Consumer surplus and producer surplus are excess amounts that remain after a product is bought or sold for an unexpectedly less or more price, respectively. BusinessZeal highlights the difference between consumer surplus and producer surplus.
The terms consumer surplus and producer surplus refer solely to the entities on the supply and demand graph. Do not confuse the term surplus with its other meanings in Heterodox economics or Marxian economics.
Economic surplus is a vital concept in the discipline of economics. Also known as total welfare surplus, it was introduced by the noted economist, Mr. Paul A. Baran. Consumer surplus and producer surplus are two very important entities under economic surplus. Both of them can be graphically represented by means of the regular demand and supply curve. To understand these entities, remember that the demand curve represents the quantity of products that the consumers can purchase at a probable price, while the supply curve represents the quantity of goods that the producers can make at a probable price. The consumer surplus vs. producer surplus comparison is elaborated in the paragraphs below.
- Assume that you have been buying a particular product for a while.
- Suddenly, for whatever reason, its price has declined and you have been unaware about the same.
- At this point, you would be willing to pay the price you think is regular, while technically, you are willing to pay more than the list price for that product.
- In short, you will be able to pay more, yet you buy the product at the reduced, current price, thus making a profit for yourself. This is called consumer surplus.
- This surplus occurs every time a consumer is able to or is ready to pay more for the product, but pays lesser and benefits from the deal.
- It is at its highest when the consumer is completely willing to pay more even for the maximum number of goods, i.e., the entire price is not lesser than the market price.
- Assume that you are a producer, and you have been selling goods for a while at a standard price.
- For whatever reason, assume that the supply rises and he agrees to reduce the price per unit. In such a scenario, he would be willing to accept the reduced amount.
- Thus, he would be willing to accept the price he thinks is nominal, while actually, he is accepting more than what he expects to make.
- Therefore, he can afford to accept the reduced price, yet he makes more; since the product is being sold for the earlier price, he is at the profitable end. This is called producer surplus.
- This occurs every time a producer is ready to accept less for the product, but accepts more and is benefited.
- This surplus is at its highest when, even for the maximum number of items to be sold, the producer is willing to accept less.
Consumer Surplus Vs. Producer Surplus
- Consumer Surplus can be defined as the surplus that is retained with the consumer after he purchases a product for which he paid lesser than what he was able to.
- Producer Surplus can be defined as the surplus that is retained with the producer after he sells a product for which he accepted more than what he was expected to receive.
A simple example of consumer surplus would be when you purchase an item for which you intend to pay USD 100, but ended up paying only USD 70. In this case, you have a consumer surplus of USD 30.
Consider another example. Let’s say, the price of a toy car is USD 10 and you intend to buy 10 pieces. Your entire expense should ideally be (10 * 10) = USD 100. At a lesser and greater price per unit, you will have more number of and less number of consumers respectively. You, as a consumer are willing to spend USD 100 on 10 pieces, but you pay USD 8 per piece due to the overall demand. Thus, you actually pay only (10 * 8) = USD 80, even if you were willing to pay USD 100. In this case, your consumer surplus is (100 – 80) = 20.
A simple example of producer surplus would be when you sell an item for which you intend to charge USD 200, but the consumer has paid USD 250. In this case, you have a producer surplus of USD 50.
Consider another example. Let’s say, the producer supplies a toy car at USD 10, and sells 20 cars to obtain USD 200. If he increases the price to USD 12 per piece, there would be a reduced demand for the toy. Thus, he will sell 20 toys only if he gets USD 10 per toy; however, he will be willing to compromise for something lesser. Now, if he thinks of selling a toy at USD 8 per piece, he will receive USD 160; but in reality, he is getting USD 200. Thus, the producer surplus is (200 – 160) = 40.
In the above consumer surplus graph, the triangle XYP represents consumer surplus. Area XYQO represents the entire benefit from consumer, for using quantity Q at price P. But, if consumers buy goods at the market price for a particular quantity, their total expense would be represented by area PYQO. This area is smaller than the entire benefit expectation. Thus, consumer surplus is area XYQO – area PYQO = area XYP.
In the above producer surplus graph, the triangle PYZ represents producer surplus. Area PYQO represents the entire revenue benefit to the producers, for selling quantity Q at price P. But, if they sell goods at the market price for a particular quantity, their total sale would be represented by area YQOZ. This area is smaller than the entire revenue for sellers. Thus, producer surplus is area PYQO – area YQOZ = area PYZ.
The consumer surplus formula can be expressed as an area of a triangle. In simple terms, you can just subtract the amount paid from the expected amount value. In more complicated problems, however, you need to gather the value from the demand curve. Consider the market price (equilibrium price) and the maximum price at which the purchased product falls to zero. Subtract the latter from the former. According to the graph, this is the height of the triangle. Consider the maximum quantity as the base. Use the formula [(1/2) * Q * P] and find out the consumer surplus.
According to the graph, the producer surplus is also represented by means of a triangle. You have to use the same formula here as well. First, find out the amount actually received by the producers due to consumer demand. Then, find the maximum price at which the sale of the product falls to zero. Find the resultant price, which is the height of the triangle. The maximum quantity of the goods sold at the unexpected price will be the base. Use the same formula – [(1/2) * Q * P] and find out the producer surplus.
The consumer and producer surplus formula depends a great deal on the demand of the consumer and the amount the producer is willing to supply. That is why gathering a demand equation from the graph is important. Accordingly, your parameters will vary and so will the final value.
The importance of the demand and supply curve in economics as well as business cannot be stressed enough. The economic surplus represented using this graph is vital to determine the rising and falling prices of goods as well as the distribution of benefits. It also represents the equilibrium point, which helps determine the balance of demand and supply.