Lecture 3

9/20/2018
Consumer surplus;
Producer Surplus;
Lecture 3
CM 625 (MBA –CPM & CEQS) SEMESTER 1
Construction Economics–
References
Myers, Danny (2013) Construction Economics – a new approach, third
edition, Routledge, London and New York.
Ball, M Fraschi, M and Grilli, (2000), Competition and the Persistence of Profits
in the UK Construction Industry, Construction Management and Economics,
18: 733-45.
Bon, R. and Crosswaithe, D. (2000) the Future of International Construction,
Thomas Telford: London.
De Valence, (ed) (2001) Modern Construction Economics: Theory and
application. Spon Press: London and New York.
Salvatore. D., “Managerial Economics”, Tata McGraw Hill.
Chan S Park, “ Fundamentals of Engineering Economics”, Pearson Education
Donald G. Newnan, Ted G Eschenbach, Jerome P.L., Engineering Economic
Analysis, Oxford University Press
1
9/20/2018

Consumer Surplus & Producer Surplus

Consumer Surplus
The difference between what you paid, and what you were willing and able
to pay.
It is the area below the demand curve,and above the equilibrium price
Consumer surplus is simply an economic measure of satisfaction.
Producer Surplus
The amount a seller is paid, minus the seller’s cost.
It is the area above the supply curve, and below the equilibrium price.
The magic of perfectly competitive markets
At equilibrium, both consumer and producer surplus are at their maximum
Any interference with the equilibrium price in perfectly competitive markets
will reduce total consumer and producer surplus
Consumer Surplus
Assumptions of
Consumer's Surplus
Price No alternative
Consumer Surplus
commodities
available
Maximum Willingness to Pay for Qo
Ceteris paribus
Po
What is paid
Qo
Quantity
2
9/20/2018

Producer Surplus
Price
Producer Surplus
Po
What is paid
Minimum Amount Needed

to Supply Qo
Qo
Quantity
Consumer and Producer Surplus
Price
Consumer S
Surplus
Po Producer Surplus
Qo
Quantity
3
9/20/2018

Change in Consumer Surplus: Price Increase
Price
New Consumer Surplus
Original Consumer
Surplus
Loss in Surplus: Consumers paying more
P1
Po Loss in Surplus: Consumers

buying less
Q1 Qo
Quantity
How the Price Affects Consumer Surplus

Consumer Surplus at Price P
Price
A
Initial
consumer
surplus
C Consumer surplus
P1
B to new consumers
F
P2
D E
Additional consumer Demand
surplus to initial
consumers
0 Q1 Q2 Quantity
Copyright©2003 Southwestern/Thomson Learning
4
9/20/2018

How the Price Affects Producer Surplus

Producer Surplus at Price P
Price
Additional producer Supply
surplus to initial
producers
D E
P2 F
B
P1
Initial C
Producer surplus
producer to new producers
surplus
0 Q1 Q2 Quantity
Copyright©2003 Southwestern/Thomson Learning
MARKET EFFICIENCY
Consumer Surplus
= Value to buyers – Amount paid by buyers
Producer Surplus
= Amount received by sellers – Cost to sellers
Total surplus / Social Welfare

= Consumer surplus + Producer surplus
or
= Value to buyers – Cost to sellers
Efficiency - the property of a resource allocation of maximizing the total

surplus received by all members of society.
5
9/20/2018

How do we compare the social welfare of two different

situations?
1. Calculate the welfare from situation 1 by summing its consumer
surplus and producer surplus:
W1 = CS1 + PS1.
2. Calculate the welfare from situation 2 by summing its consumer
surplus and producer surplus:
W2 = CS2 + PS2.
3. Calculate the difference,
W2 – W1 = (CS2 + PS2) – (CS1 + PS1).
This tells us the gain or loss of welfare of one situation relative to the
other.
When a policy results in a loss of welfare to society, that loss is often
referred to as the deadweight loss.
Notice that we just calculated the social

welfare gain or loss as the difference in
combined consumer and producer surplus,
W2 – W1 = (CS2 + PS2) – (CS1 + PS1).
An alternative equivalent way is the following.
1. Calculate the change in consumer surplus:

∆CS = CS2 – CS1 .
2. Calculate the change in producer surplus:
∆PS = PS2 – PS1 .
3. Add to get the total gain or loss in social welfare:
∆CS + ∆PS = (CS2 – CS1) + (PS2 – PS1)
6
9/20/2018

At quantity Q1 & price P1, consumer surplus is the purple area &
producer surplus is the green area.
P
S
P1
Q1 Q
As we increase the quantity & reduce the price, the total area
of the consumer & producer surpluses increases,
P
S
P2
Q2 Q
7
Construction Economics– Construction Economics–
CM 625 (MBA –CPM & CEQS) SEMESTER 1 CM 625 (MBA –CPM & CEQS) SEMESTER 1
P
P
P3
P*
Q3
Q*
and increases,
D
D
S
S
Q
Q
until we reach the perfectly competitive equilibrium.

9/20/2018
8
9/20/2018

. Price Ceilings
Without
the
P
ceiling S
our
consumer
&
producer
P*
surpluses
are as
shown by
the purple D
& green
areas Q* Q
With price ceiling, Pc , the consumer & producer surpluses are

as shown.
P
S
Pc
Qc Q
9
9/20/2018

Consumers have lost area V but gained area U.
P
S
V
U
Pc
Qc Q
The consumers who gain are those who get the product at a lower
price.The consumers who lose are those who are no longer
able to buy the product because there is less supplied.
P
S
V
U
Pc
D
Qc Q
10
9/20/2018

In the graph shown, area U is larger than area V, so consumers as a

whole gain. However, if area U is smaller than area V, consumers lose.
P
S
V
Pc U
Qc Q
Producers have lost areas U and W.
P
S
U W
Pc
Qc Q
11
9/20/2018

So area U just moved from producers to consumers, but areas

V and W were lost to everyone.
P
S
V
U W
Pc
Qc Q
Area V+W is the difference in the total consumer and producer

surplus with and without the policy
(CS2 + PS2) – (CS1 + PS1).
P
S
V It is the deadweight
W loss to society that
Pc results from the policy.
Qc Q
12
9/20/2018

Price Ceiling Example: Rent Controls

Suppose in the absence of controls, equilibrium rent would be 8 thousand
dollars per year & equilibrium quantity would be
2 million apartments.
Rent
(thousands of
dollars per year) S
D
0 2.0 Quantity of
apartments
(millions)
Next suppose that a price ceiling of 7 thousand dollars is imposed. As a

result the quantity supplied drops to 1.8 million.
Rent
(thousands of
dollars per year) S
8
7
D
0 1.8 2.0 Quantity of
apartments
(millions)
13
9/20/2018

Based on the graph, determine the effects

on consumers, producers, & society as a whole.
Rent
(thousands of
dollars per year) S
9
8
7
D
apartments
(millions)
Recall that consumers gain area U and lose area V.

Producers lose areas U and W.
Rent
(thousands of
dollars per year) S
9
V
8 W
U
7
D
apartments
(millions)
14
9/20/2018

U = (1.8 million) (8,000 – 7,000) = $1,800 million

V = (1/2)(0.2 million)(1,000) = $100 million
W = (1/2)(0.2 million)(1,000) = $100 million
Rent
(thousands of
dollars per year) S
9
V
8 W
U
7
D
apartments
(millions)
Consumers gain
U – V = $1,800 million - $100 million = $1,700 million.
Producers lose
U + W = $1,800 million + $100 million = $1,900 million
Rent
(thousands of
dollars per year) S
9
V
8 W
U
7
D
apartments
(millions)
15
9/20/2018

Producers lose $200 million dollars more than consumers gain.

So there is a deadweight loss of $200 million per year.
Rent
(thousands of
dollars per year) S
9
V
8 W
U
7
D
apartments
(millions)
Loss in Efficiency
Too High of Price (Price Floor)
Price Deadweight Loss

Lost
New
Consumer S
Surplus
Consumer
Surplus
PH
Po Lost Producer Surplus
New
Producer
Surplus
D
QL Qo
Quantity
16
9/20/2018

Loss in Efficiency
Too Low of Price (Price Ceiling)
Price Deadweight Loss

Lost
Consumer S
Surplus
New
Consumer
Surplus
PL
New
Producer
Surplus D
QL Qo
Quantity
Loss in Efficiency
Taxation
STax
Price
Tax
S
New Consumer
Surplus Lost Consumer
Surplus Deadweight Loss
PD
Tax
Revenues
PS
New
Producer
Surplus D
QL Qo
Quantity
17
9/20/2018

Loss in Efficiency
Subsidy
Price
Gain in Producer Surplus S

New
Consumer
Surplus PS SSub
Subsidy
Gain in Po
Consumer
Surplus PD Deadweight Loss
New Producer D
Subsidy Cost
Surplus
Qo QH
Quantity
Suppose a tax of $0.25 per unit is imposed on an item.
S’
P
$0.25 S
From the
consumer’s
perspective, it
is as if the 1.50
supply curve
has shifted up
vertically by the
tax amount of D
$0.25.
50 Q
18
9/20/2018

The equilibrium quantity falls & the equilibrium price rises.
S’
P
$0.25 S
Although the $0.25
price rises, it
does not 1.50
rise by the
full amount
of the tax.
D
40 50 Q
The buyer pays (in this example) 15 cents more than before.
The seller gets 25 cents less than the buyer pays.
So the seller gets 10 cents less than before.
S’
P
$0.25 S
1.65
1.50
1.40
D
40 50 Q
19
9/20/2018

Consumer surplus falls by area U + V.
S’
P
S
1.65
U
V
1.50
1.40
D
40 50 Q
Producer surplus falls by area X + W.
S’
P
S
1.65
1.50 W
X
1.40
D
40 50 Q
20
9/20/2018

Tax revenues equal the tax per unit times the number of
units sold.
So the area U + X is the government tax revenue.
S’
P
S
1.65
U
1.50
X
1.40
D
0 40 50 Q
The total change in social welfare is the change in consumer surplus

[-(U + V)] plus the change in producer surplus [-(X + W)] plus the
government revenue (U + X), which equals
[-U - V] + [-X - W] + (U + X) = – V – W or – (V + W) .
S’
P
S
1.65
U
V The negative sign in front
1.50 W of the V + W indicates
X
1.40 that it is a loss of V + W.
D
0 40 50 Q
21
9/20/2018

So area V + W is deadweight loss.
S’
P
S
1.65
V
1.50 W
1.40
D
0 40 50 Q
Size of Deadweight Loss
The deadweight loss of the tax will depend upon two factors:
The size of the tax
The reduction in the quantity sold
The reduction in the quantity sold will depend upon the elasticity of
demand and supply
The more elastic demand or supply is the larger the deadweight loss will be
If either demand or supply is price inelastic then the deadweight loss will small and
could be zero if perfectly inelastic (no change in the quantity sold and
consumed)
22
9/20/2018

Consumers’ Surplus
The demand function d (x) and the market price A must

be given in the problem. Then B = d (A), and you can
plug the information into the equation.
A
Consumers' Surplus = ∫ [d (x) − d (A)] dx
0
$ Consumers’
Graphically surplus
Price
Market price d (x)
B = d (A)
A Quantity x
Consumer & Producer surplus
23
9/20/2018

How a Tax Effects Welfare

Supply with TAX
Price
A Supply
Price
buyers = PB
pay
B
Price C
without tax= P1
E
Price D
sellers = PS
receive F
Demand
0 Q2 Q1 Quantity
Copyright © 2004 South-Western

How a Tax Effects Welfare

Supply with TAX
Price
A Supply
Price
buyers = PB
pay
B
Price C
without tax= P1
E
Price D
sellers = PS
receive F
Demand
0 Q2 Q1 Quantity
Copyright © 2004 South-Western
24
SOCIAL WELFARE IN CASE OF SUBSIDY

OF SUBSIDY
SOCIAL WELFARE IN CASE
9/20/2018
25
9/20/2018

Problem 1
a. equilibrium price before the tax

b. consumer surplus before the tax
c. producer surplus before the tax
d. total surplus before the tax
e. consumer surplus after the tax
f. producer surplus after the tax
g. total tax revenue to the government
h. total surplus (consumer surplus + producer
surplus + tax revenue) after the tax
i. deadweight loss
Solution 1
a. $10
b. $3600
c. $2400
d. $6000
e. $900
f. $600
g. $3000
h. $4500
i. $1500
26
9/20/2018

Problem 2
Demand: P = 15 - Q (Pe = 9)
Calculate consumer surplus
Problem 3
Demand: P = 240 - 6Qd

Supply: P = 120 + 4Qs
Answering below questions and graph two different diagrams.
A. Calculate consumer surplus and producer surplus at the market equilibrium.
B. Now a new per unit tax of 20 is introduced. Calculate the tax receipts and
the new CS, the new PS as well as the deadweight loss.
27
Solution 4
Solution 3
9/20/2018
28
9/20/2018

Problem
Consider the market for cement with inverse

demand given by P=30-2*QD and inverse supply
given by P=10+2*QS. Now suppose the government
implements a price subsidy program with a target
price of 24 units. Compute Deadweight loss for this
scenario.
29
Subsidy on CS and PS
Effect of Price Floor plus
9/20/2018
30

Lecture 3

Caricato da

Informazioni sul documento

Copyright

Formati disponibili

Condividi questo documento

Condividi o incorpora il documento

Opzioni di condivisione

Hai trovato utile questo documento?

Questo contenuto è inappropriato?

Copyright:

Formati disponibili

Lecture 3

Caricato da

Copyright:

Formati disponibili

9/20/2018

CM 625 (MBA –CPM & CEQS) SEMESTER 1

Consumer Surplus & Producer Surplus

CM 625 (MBA –CPM & CEQS) SEMESTER 1

Minimum Amount Needed

Consumer and Producer Surplus

CM 625 (MBA –CPM & CEQS) SEMESTER 1

Change in Consumer Surplus: Price Increase

Po Loss in Surplus: Consumers

How the Price Affects Consumer Surplus

Copyright©2003 Southwestern/Thomson Learning

CM 625 (MBA –CPM & CEQS) SEMESTER 1

How the Price Affects Producer Surplus

Total surplus / Social Welfare

Efficiency - the property of a resource allocation of maximizing the total

CM 625 (MBA –CPM & CEQS) SEMESTER 1

How do we compare the social welfare of two different

Notice that we just calculated the social

1. Calculate the change in consumer surplus:

CM 625 (MBA –CPM & CEQS) SEMESTER 1

until we reach the perfectly competitive equilibrium.

CM 625 (MBA –CPM & CEQS) SEMESTER 1

With price ceiling, Pc , the consumer & producer surpluses are

CM 625 (MBA –CPM & CEQS) SEMESTER 1

Consumers have lost area V but gained area U.

CM 625 (MBA –CPM & CEQS) SEMESTER 1

In the graph shown, area U is larger than area V, so consumers as a

Producers have lost areas U and W.

CM 625 (MBA –CPM & CEQS) SEMESTER 1

So area U just moved from producers to consumers, but areas

Area V+W is the difference in the total consumer and producer

CM 625 (MBA –CPM & CEQS) SEMESTER 1

Price Ceiling Example: Rent Controls

Next suppose that a price ceiling of 7 thousand dollars is imposed. As a

CM 625 (MBA –CPM & CEQS) SEMESTER 1

Based on the graph, determine the effects

Recall that consumers gain area U and lose area V.

CM 625 (MBA –CPM & CEQS) SEMESTER 1

U = (1.8 million) (8,000 – 7,000) = $1,800 million

CM 625 (MBA –CPM & CEQS) SEMESTER 1

Producers lose $200 million dollars more than consumers gain.

Price Deadweight Loss

Po Lost Producer Surplus

CM 625 (MBA –CPM & CEQS) SEMESTER 1

Price Deadweight Loss

Po Lost Producer Surplus

CM 625 (MBA –CPM & CEQS) SEMESTER 1

Gain in Producer Surplus S

Suppose a tax of $0.25 per unit is imposed on an item.

CM 625 (MBA –CPM & CEQS) SEMESTER 1

The equilibrium quantity falls & the equilibrium price rises.

CM 625 (MBA –CPM & CEQS) SEMESTER 1

Consumer surplus falls by area U + V.

Producer surplus falls by area X + W.

CM 625 (MBA –CPM & CEQS) SEMESTER 1

The total change in social welfare is the change in consumer surplus

CM 625 (MBA –CPM & CEQS) SEMESTER 1

So area V + W is deadweight loss.

Size of Deadweight Loss

CM 625 (MBA –CPM & CEQS) SEMESTER 1

The demand function d (x) and the market price A must

Consumer & Producer surplus

CM 625 (MBA –CPM & CEQS) SEMESTER 1

How a Tax Effects Welfare