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Surplus Measures

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An Alternative View of the Demand Curve An alternative interpretation of the demand

curve is that it represents the consumer’s marginal willingness to pay or $marginal benefit for the quantity specified.

So, another way of looking at the demand curve is that it tells you the $marginal benefit at each unit of consumption.

$Total benefit of consumption would then be the sum of all the marginal benefits up to, say, X units.

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Willingness to Pay

Think of the total amount you would pay for X units (say it is $27) and then for X-1 units (say it is $25). Your marginal willingness to pay for that Xth unit is $2 (= 27 -25).

Alternatively, we could say that your quantity demanded at the price $2/unit is X because you are willing to pay up to $2/unit for the Xth unit.

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Consumers Surplus For one individual: consumer’s surplus (CS)

is the difference between the consumer’s total willingness to pay ($total benefit) and what the consumer actually did pay ($total expenditure).

CS = the area between the consumer’s demand curve and the market price line.

To go from individual consumer’s surplus to market consumers’ surplus, just use the market demand, which aggregates all the individuals.

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Example: Li’s Willingness to Pay for Wheat and Consumer Surplus

The table at the right shows Li’s willingness to pay for the indicated quantities of wheat.

Her marginal marginal willingness to pay (marginal benefit) is the difference between her willingness to pay for X and X-1 units of wheat.

Li’s demand curve would be the plot of her marginal willingness to pay against number of units.

Marginal consumer surplus on each unit is the difference between marginal willingness to pay and the price she actually pays, PW=$2/lb in this example.

Total consumer surplus is the sum of all entries in the marginal consumer surplus column.

Li's Willingness to Pay Li's Willingness to Pay

Quantity of Wheat

Total Willingness

to Pay

Marginal Willingness

to PayMarket

Price

Marginal Consumer

Surplus

Total Consumer

Surplus0 0.00 2.00 1 34.00 34.00 2.00 32.00 32.002 49.00 15.00 2.00 13.00 45.003 61.25 12.25 2.00 10.25 55.254 70.75 9.50 2.00 7.50 62.755 77.50 6.75 2.00 4.75 67.506 81.50 4.00 2.00 2.00 69.507 85.00 3.50 2.00 1.50 71.008 88.00 3.00 2.00 1.00 72.009 90.50 2.50 2.00 0.50 72.50

10 92.50 2.00 2.00 0.00 72.5011 94.33 1.83 2.00 12 96.00 1.67 2.00 13 97.50 1.50 2.00 14 98.83 1.33 2.00 15 100.00 1.17 2.00 16 101.00 1.00 2.00 17 101.88 0.88 2.00 18 102.63 0.75 2.00 19 103.25 0.63 2.00 20 103.75 0.50 2.00

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Consumer Surplus and Quantity Demanded

If the price of wheat is $2/lb., then Li buys 10 lbs. of wheat, the point where her marginal benefit of wheat equals its price.

Notice that the marginal willingness to pay column (marginal benefit) is just Li’s demand for wheat.

When PW=$2 and W=10, Li’s consumer surplus is $72.50, indicating that she would have been willing to pay an additional $72.50 for the wheat she consumed (above the $20 she had to pay).

Try it for PW = $4.00

Li's Willingness to Pay Li's Willingness to Pay

Quantity of Wheat

Total Willingness

to Pay

Marginal Willingness

to PayMarket

Price

Marginal Consumer

Surplus

Total Consumer

Surplus0 0.00 2.00 1 34.00 34.00 2.00 32.00 32.002 49.00 15.00 2.00 13.00 45.003 61.25 12.25 2.00 10.25 55.254 70.75 9.50 2.00 7.50 62.755 77.50 6.75 2.00 4.75 67.506 81.50 4.00 2.00 2.00 69.507 85.00 3.50 2.00 1.50 71.008 88.00 3.00 2.00 1.00 72.009 90.50 2.50 2.00 0.50 72.50

10 92.50 2.00 2.00 0.00 72.5011 94.33 1.83 2.00 12 96.00 1.67 2.00 13 97.50 1.50 2.00 14 98.83 1.33 2.00 15 100.00 1.17 2.00 16 101.00 1.00 2.00 17 101.88 0.88 2.00 18 102.63 0.75 2.00 19 103.25 0.63 2.00 20 103.75 0.50 2.00

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Graphical Measure of Li’s Consumer Surplus

The area under the demand curve and above the market price is the total consumer surplus.

The arrow on the right shows Li’s total consumer surplus when the market price of wheat is $2/lb.

Li's Consumer Surplus from Wheat

0

5

10

15

20

25

30

0 2 4 6 8 10 12 14 16 18 20

Wheat

Ma

rgin

al W

illin

gn

es

s t

o P

ay

The area below the demand curve above the market price is Li's total consumer surplus

Market Price of Wheat

Demand for Wheat = Marginal Willingness to Pay

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Market Consumer Surplus Question

The table at the right is a sample market demand curve.

Question: At a market price of $2.00, what is the total consumer surplus?

Quantity

Marginal Willingness to

Pay = Marginal Benefit =

Demand Price01 12.002 8.003 6.004 5.005 4.006 3.007 2.008 1.009 0.50

10 0.2511 0.1312 0.00

Sample Market Demand Curve

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Market Consumer Surplus Answer

At a market price of $2.00, total expenditures are $14 = 7 x $2.00

Total willingness to pay is $40 = 12 + 8 + 6 + 5 + 4 + 3 + 2.

Total consumer surplus = $40 - $14 = $26.

Total consumer surplus = sum of marginal consumer surplus = 26 = 10 + 6 + 4 + 3 + 2 + 1 + 0.

Quantity

Marginal Willingness

to Pay = Marginal Benefit = Demand Market Price

Marginal Consumer

Surplus

Total Consumer

Surplus0 2.001 12.00 2.00 10.00 102 8.00 2.00 6.00 163 6.00 2.00 4.00 204 5.00 2.00 3.00 235 4.00 2.00 2.00 256 3.00 2.00 1.00 267 2.00 2.00 0.00 268 1.00 2.009 0.50 2.00

10 0.25 2.0011 0.13 2.0012 0.00 2.00

Sample Market Demand Curve

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Graph of Market Consumer Surplus

As in the case of individual consumer surplus, the area below the demand curve and above the market price measures the total market consumer surplus.

Market Consumer Surplus

0

2

4

6

8

10

12

0 2 4 6 8 10 12

Quantity

Pri

ce

Market Consumer Surplus is the area under the demand curve above the market price.

Market Demand

Market Price

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Why Measure Consumer Surplus?

An individual’s total consumer surplus on a purchase measures the gain to the consumer from the market transaction.

In the market as a whole, the total consumer surplus measures the gain to society from the existence of the market equilibrium price.

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Producers Surplus Producers surplus measures the gain to firms from selling all units

at the market price. Producers surplus is the supply-side equivalent of consumers

surplus. Think of the supply curve as measuring the marginal costs of

production. For one firm: producer’s surplus (PS) is the difference between

what the firm gets in revenue ($total revenue) and what the sum of the marginal costs are ($total variable costs).

PS = the area between the market price line and the firm’s supply curve.

To go from individual producer’s surplus to market producers’ surplus, just use the market supply, which aggregates all the firms.

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Producers Surplus

Demand=MB

Supply=MC

P

Quantity

P*

X*

Suppose the market equilibrium occurs at P* & X*.

Total revenue to producers is the area OP*BX*.

Sum of marginal costs is the area OABX*.

Producers surplus is the red shaded area AP*B.

A

B

O

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Demand and Supply Revisited Market demand reflects marginal benefit. Market supply reflects marginal costs. Consumers surplus measures the gains from

trade to the consumers. Producers surplus measures the gains from

trade to the producers. Total gains from trade - or total surplus - or

net social surplus - is the sum of consumers and producers surplus. It can also be thought of as $total benefit-sum of $marginal costs.

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Net Social Surplus

Demand=MB

Supply=MC

$

Quantity

P*

X*

The market equilibrium occurs at P* & X*.

$TB = area OCBX* $total expenditure = area

OP*BX* $CS is the top blue

shaded area P*CB $total revenue =area

OP*BX* sum of $mc = OABX* $PS = bottom red

shaded area AP*B $Net social surplus =

area ACB = the top and bottom triangles.

B

O

A

C

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Selling My House Old address: 133 Tompkins St. New address: 132 Tompkins St. Problem: we bought the new house before

selling the old one. Our minimum selling price (after 2 years) =

$55,000. Potential buyer Abe: maximum buying price =

$45,000 So, no deal with Abe.

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Selling My House Potential (and last) buyer Betty: maximum price = $95,000 Trade should occur! Net social surplus on trade = $40,000 Remember: Our minimum selling price (after 2 years) = $55,000. Division of surplus to the Wissink’s and to Betty depends on the strike

price - what we sell the house for. Suppose we sold it for $90,000.

HA! Consumers surplus=$5,000 and Producers surplus=$35,000. What did we sell it for? Don’t ask!