Consumers are assumed to be trying to maximize their utility, i.e., the satisfaction they gain from consuming a product. They choose a certain quantity of goods that would maximize their utility with their limited income. Consumer Surplus and Producer Surplus represent different areas on demand and supply curve respectively.
Consumer Surplus is the area under the demand curve that represents the difference between what a consumer is willing and able to pay for a product and what the consumer actually ends up paying. The formula for calculating consumer surplus is 1/2 base x height. Consumer surplus is positive when the price the consumer is willing to pay is more than the market price.
Calculating Consumer Surplus
In this graph, the consumer surplus is = 1/2 base x height =
The market price is $18 with quantity demanded at 20 units (what the consumer actually ends up paying), while $30 is the maximum price someone is willing to pay for a single unit. The base is $20.
1/2 x (20) x [(30-18)] = $120
The Producer Surplus is the area under the supply curve that represents the difference between what a producer is willing and able to accept for selling a product and what the producer sells it for. The formula for calculating producer surplus is 1/2 base x height.
Calculating Producer Surplus
In this graph, the producer surplus is = 1/2 base x height =
1/2 (20) x (25-5) = $200
The market price is $25 with quantity supplied at 20 units (what the producer actually ends up producing), while $5 is the minimum price the producer is willing to accept for a single unit. The base is $20.
Consumer Surplus and Producer Surplus Examples
Coffee is a good example of a product because it is essentially the same across all producers. However, depending on where it is sold, the price of a cup of coffee can vary widely. Starbucks can charge more than McDonald’s for a cup of coffee because coffee drinkers have strong preferences regarding where they buy their coffee drinks and what they believe is a reasonable price for a cup of coffee. The difference between the lowest available price for a cup of coffee and the highest price is the producer surplus.
If a producer can perfectly price discriminate, it could theoretically capture the entire economic surplus. Perfect price discrimination would entail charging every single customer the maximum price he would be willing to pay for the product.