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Economics

# Understanding Consumer & Producer Surplus

## Sarah Thomas

Subject Matter Expert

Learn about consumer and producer surplus, their formula, how they affect the economy, and how the elasticity of goods can affect them.

## What Is Consumer Surplus?

In economics, consumer surplus is the difference between the maximum price consumers are willing to pay for a good and the actual price they pay.

Imagine you’re thirsty and craving a soda.

You’re willing to pay $5 for a can, but you find a vending machine selling sodas for$1. Your consumer surplus—if you buy the soda—is the benefit you get from paying less for the can than you were otherwise willing to pay. In this case, your consumer surplus is $4—the$5 you were willing to pay minus the $1 you ‌pay. $\text{Consumer Surplus = Willingness to Pay - Price}$ ## What Does Consumer Surplus Look Like? On a supply and demand graph with linear (straight) supply and demand curves, a triangle represents consumer surplus. These 3 items form the sides of this triangle: 1. The vertical axis of the graph 2. A horizontal line placed where the market price (or equilibrium price) is 3. The demand curve In the supply and demand graph above, triangle ABC represents the total consumer surplus. It represents all of the combined consumer surpluses ‌buyers in the markets have gained across all transactions. ### How To Calculate Consumer Surplus on a Graph To calculate total consumer surplus, all you have to do is calculate the area of the consumer surplus triangle. The area of a triangle is equal to ½ the base of the triangle times its height. $\text{Total Consumer Surplus = Area of Consumer Surplus Triangle}$ $\text{Area of Consumer Surplus Triangle =} \frac{1}{2}\text{Base x Height}$ In our example, consumer surplus equals: ½ x 60 x 40 =$1200.

Again, this area is the sum of all consumer surpluses gained from each transaction in the market.

For example, for the 10th unit sold, somebody in the market was willing to pay about $83 but purchased the unit for$50. This buyer gained a consumer surplus of $33. The buyer of the 20th unit had a consumer surplus equal to$76-$50 or$26, and so on. If we add up the individual surpluses gained from each of the 60 units sold, we would get an amount equal to the area of the triangle.

## What Is Producer Surplus?

Producer surplus is the difference between what a seller receives as payment for a product (the price) and the lowest price they were willing to accept.

Imagine you’re an artist.

You create a sculpture ‌you’re willing to sell for $30. A buyer enters your gallery and falls in love with your work. Before you even have a chance to say how much it costs, the buyer offers you$100 for the sculpture. Your producer surplus if you sell the piece to this customer is the benefit you get from selling at a higher price than you were willing to charge.

## How Does Surplus Affect the Economy?

Economists refer to the combined value of consumer and producer surplus as total social surplus or total economic surplus.

Total surplus in a market represents all the net benefits gained from trade in a particular market. It represents the degree to which market participants are better off due to buying and selling.

In a perfectly competitive market, total social surplus is maximized at the market equilibrium price and quantity. All buyers willing to pay at or above the market price have been matched with sellers willingness to sell at equal or below the market price.

The equilibrium point represents an allocation that is economically efficient.

At any quantity below the equilibrium quantity, there will be gains from trade that haven’t been realized. This means there will still be sellers and buyers who could benefit from trade but are not. This amount of unrealized potential surplus is called deadweight loss. At the equilibrium point, ‌no deadweight loss exists.

At any quantity above the equilibrium quantity, the price ‌sellers are willing to accept is higher than the price ‌buyers are willing to pay. This means any transaction would result in a net loss (rather than a net gain) for market participants.

## How Does Elasticity Impact the Consumer and Producer Surplus?

### Price Elasticity of Demand

Price elasticity of demand measures changes in quantity demanded relative to changes in price. It tells you whether consumers will adjust the quantities they demand by a lot or a little in response to a change in price.

Dr. Homa Zarghamee is one instructor of Outlier.org's Principles of Economics. She explains price elasticity of demand:

#### Elastic demand

When consumer demand is sensitive to price changes—i.e., quantity demanded changes by a lot relative to price—demand is elastic. The flatter a demand curve is, the more elastic demand is.

When demand is perfectly elastic, the demand curve is a horizontal line, and consumer surplus will equal zero.

#### Inelastic demand

When consumer demand is insensitive to changes in price—i.e., quantity demanded changes by a little relative to price—demand is inelastic. The steeper the demand curve is, the more inelastic consumer demand is.

When demand is perfectly inelastic, the demand curve is a vertical line, and consumer surplus will be infinite.

### Price Elasticity of Supply

Price elasticity of supply measures changes in quantity supply relative to changes in price. It tells you whether sellers will adjust the quantity supplied by a lot or little in response to a change in the market price.

#### Elastic supply

When consumer demand is sensitive to price changes—i.e., quantity demanded changes by a lot relative to price)—demand is elastic. The flatter a supply curve is, the more elastic demand is.

When supply is perfectly elastic, the supply curve is a horizontal line, and producer surplus will equal zero.

#### Inelastic supply

When consumer demand is insensitive to price changes—i.e., quantity demanded changes by a little relative to price—demand is said to be inelastic. The steeper the demand curve is, the more inelastic consumer demand is. When supply is perfectly inelastic, the supply curve is a vertical line, and producer surplus will be infinite.

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