AMITY GLOBAL

BUSINESS SCHOOL Noida

1
BBA
Consumer Surplus
Mr. Sachin Rohatgi
AMITY GLOBAL
BUSINESS SCHOOL Noida
Market Equilibrium
Earlier, we saw that
market equilibrium occurs
when the quantity of a
good offered by sellers at
a given price equals the
quantity buyers are willing
and able to purchase at
that same price.

That is, market
equilibrium occurs at price
equals P
*
and quantity
equals Q
*
.
Q
P
D
S
Q
*

P
*

AMITY GLOBAL
BUSINESS SCHOOL Noida
Measuring the Gains from Trade
Whenever an exchange (or trade) takes place between a
consumer and a producer, both parties gain from that
exchange (or trade)
The consumers gain from the trade is termed as
The consumers surplus
The producers gain from the trade is termed as
The producers surplus
The sum of the consumers and producers surplus
is the total gains from a particular trade (or
exchange).
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BUSINESS SCHOOL Noida
Consumer Surplus

Willingness to pay- the maximum price a consumer
would pay
how much a consumer values a good/service
called the marginal benefit (MB)

Consumer Surplus- buyers willingness to pay minus
price paid

CS = MB Price Paid

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AMITY GLOBAL
BUSINESS SCHOOL Noida
Consumer Surplus

When you purchase something for a price that is less
than your maximum willingness to pay?
E.g. you are willing to pay Rs.20,000 for a new car
and you buy it for Rs.18,000 here;
You receive a surplus of willingness to pay
cost =Rs.2,000.

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BUSINESS SCHOOL Noida
Consumer Surplus - Example
Assume a boy wants to buy a cake.
Demand curve tells his willingness to pay for each
piece of cake.
1
st
cake is worth Rs. 20 but price is Rs.14 so he
generates Rs.6 worth of surplus.
We can measure this for each piece of cake.
Total surplus is sum of surplus from each cake
purchased.
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BUSINESS SCHOOL Noida
The consumer surplus
of purchasing 6 pieces of
cake is the sum of the
surplus derived from
each one individually.
Consumer Surplus
6 + 5 + 4 + 3 + 2 + 1 = 21
Consumer Surplus - Example
Piece of cakes
Price
(Rs. Per
Cake)
2 3 4 5 6
13
0 1
14
15
16
17
18
19
20
Market Price
Will not buy more than 7
because surplus from
additional ticket is negative
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BUSINESS SCHOOL Noida
Consumer Surplus
The stepladder demand curve can be converted into a
straight-line demand curve by making the units of the
good smaller.
Consumer surplus measures the total net benefit to
consumers =
total benefits from consumption (-)the total expenses.
Thus, consumer surplus is area under the demand
curve and above the price.
Note that the area under the demand curve up to the
level of consumption measures the total benefits.
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BUSINESS SCHOOL Noida
Demand Curve
Consumer
Surplus
Consumer Surplus
Piece of cake
Price
(Rs. per
cake)
2 3 4 5 6 0 1
Actual
Expenditure
14
20
Market Price
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BUSINESS SCHOOL Noida
Consumer Surplus and Market Price
A lower market price will usually increase
consumer surplus.
A higher market price will usually reduce
consumer surplus.
Consumer surplus will be smaller when the
demand curve is more elastic and larger when the
demand curve is inelastic.
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BUSINESS SCHOOL Noida
How the Price Affects Consumer Surplus?
Initial
consumer
surplus
Quantity
Consumer Surplus at Price P2
vs. at Price P1
Price
0
Demand
A
B
C
D E
F
P1
Q1
P2
Q2
Consumer surplus
to new consumers
Additional consumer
surplus to initial
consumers
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BUSINESS SCHOOL Noida
Consumer Surplus
Price
Quantity
D
P
o

Q
o

Maximum Willingness to Pay for Q
o

What is paid
Consumer Surplus
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Original Consumer
Surplus
Change in Consumer Surplus: Price
Increase
Quantity
New Consumer Surplus
Loss in Surplus: Consumers paying more
Loss in Surplus: Consumers
buying less
Price
D
P
o

Q
o

P
1

Q
1

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BUSINESS SCHOOL Noida
Producer Surplus

The amount a seller is paid , minus the sellers cost.

It is the area above the supply curve, and below the
equilibrium price.

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BUSINESS SCHOOL Noida
Minimum Amount Needed to
Supply Q
o

Producer Surplus
Price
Quantity
P
o

Q
o

What is paid
Producer Surplus
S
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BUSINESS SCHOOL Noida
Consumer and Producer Surplus
Price
Quantity
P
o

Q
o

S
Producer Surplus
Consumer
Surplus
D
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BUSINESS SCHOOL Noida
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
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BUSINESS SCHOOL Noida
Consumers and Producers Surpluses
A Mathematical Application
Suppose that the demand and supply function are given by
Q
D
= 40 2P
Q
S
= 2P

Market equilibrium occurs at the intersection of the demand and
supply functions. Thus, at the market equilibrium Q
S
= Q
D


Now, setting Q
S
= Q
D
, we have
40 2P = 2P => 4P = 40 => P* = 10 (equilibrium price)
Plugging the equilibrium price to either the demand or supply
function
Q
D
= 40 2(10) => Q
D
= 20
Q
D
= 20 = Q
S
(equilibrium quantity)


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BUSINESS SCHOOL Noida
Consumers and Producers Surpluses :A Mathematical
Application
The consumers surplus is the area of the triangle between the price line
and demand curve
For Q
D
= 20, P = 10 (the equilibrium price and quantity exchanged)
For Q
D
= 0, P = 20 (this is the vertical intercept of the inverse demand
function)
The vertical intercept above the price line is (20-10=) 10
The area of the triangle between the price line and the demand curve, i.e.,
CS= (1/2)*20*10 = 100
The producers surplus is the area of the triangle between the price line
and supply curve
For Q
S
= 20, P = 10 (the equilibrium price and quantity exchanged)
The vertical intercept above the price line is 10
The area of the triangle between the price line and the supply curve, i.e.,
PS= (1/2)*20*10 = 100
The total surplus, TS = CS + PS = 100+100 = 200
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BUSINESS SCHOOL Noida
Total Economic Surplus or Social Surplus
Total Economic Surplus or Social Surplus: The sum of the
surpluses from trade of a commodity or service to all
participants (all consumers and producers)
Total economic surplus from all exchanges of a commodity
occurred at a particular point in time can be calculated in the
same way, using the aggregate (market) demand and supply
functions (curves)
Consumers surplus is the area of the triangle between the
equilibrium price line and the market demand curve
Producers surplus is the area of the triangle between the
equilibrium price line and the market supply curve
Economic Surplus = Consumers Surplus + rooducers Surplus