Friday, 23 January 2015

Consumer Surplus and Producer Surplus

What is Consumer Surplus?
Consumers surplus is the difference between what the consumers are willing to pay for a product and the actual market price that they are paying for it. It is measured in monetary value in economics. It is the amount of extra utility derived by him for which he has not paid any money or value.

So, consumer surplus is a kind of extra advantage gained or money saved by the consumer. It is the measurement of the extra satisfaction that the consumer derives from that product. Here the consumer does not bother paying even an increased price to have that product, because he is getting much satisfaction from that product than he is actually paying to procure it.

For example, a consumer goes to the market to purchase sugar expecting the price to be Rs.50 per kg. But when he actually purchases it, he finds that he is charged with only Rs. 35 per kg. So, it is assumed that the consumer has derived a surplus satisfaction of Rs.15 which is his consumer surplus.

Buyers always think in terms of the extra satisfaction they derive when buying goods. They always look for products which give them most satisfaction and then bargain to pay much lesser amount than the actual utility that is derived by them. So, generally, consumers always enjoy some amount of consumer surplus from most of their purchases.

So,when the prices increase consumer surplus decreases and when the prices fall the consumer surplus increases.

Graphically, consumer's surplus can be described as the area below the demand curve and above the price line.

What is Producer Surplus?
Just like consumers enjoy surplus satisfaction from their purchases, the producers of product or the suppliers of it also enjoy extra benefits. It is the extra income that they get by selling goods at a price higher than what otherwise they would have been forced to sell. 

The producers may be willing to sell their products at a lower price than the present market price so as to carry on their business rather than wind up. So, by selling at present market price, they are enjoying extra income. This amount of income that they are receiving by selling the product at present market price (say 'x') instead of selling it otherwise at a lower price (say 'y') is their surplus. So they are enjoying a producer surplus of x-y amount multiplied by the quantity sold. This is their "producer surplus". 

The above is illustrated in the graph below.

The blue line indicates demand curve. The red line indicates the supply curve.
Both lines are intersecting at a point where the price level is Rs.500 at Price-3 point. This is the point where demand and supply are equal.

If you draw a line connecting the intersecting point to the Y-axis (vertical line), the consumer surplus will be equal to the volume of satisfaction that he enjoys from this line upto the tip of the demand curve at Rs.1000.

Similarly, the producer surplus will be equal to the volume of satisfaction in between the lines at price level 500 and price level 200 above the supply curve. ( I was unable to shade these portions with colour to be clear for you.)

(Click on the image to view it in larger size please).

I hope you are clear now about the concepts of Consumer Surplus and Producer Surplus. You may clear any doubts by asking in the comments section.

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