Markets and Economic Welfare - Objective 1: Consumer
Surplus and Producer Surplus
4.1.1 Consumer Surplus
The concept of willingness to pay relates to the maximum amount a consumer will pay for a
product. Consumer surplus, therefore, is a consumer’s willingness to pay, minus the
amount actually paid for a product. Graphically, the area below the demand curve and
above the price measures the consumer surplus in a market. A reduction in the product’s
price raises consumer surplus due to two reasons. First, existing buyers now pay a lower
price, and second, a lower price induces new buyers to enter the market. The concept of
consumer surplus is a good measure of economic well-being because it incorporates the
preference of buyers by examining their willingness to pay.
4.1.2 Producer Surplus
Let us now evaluate the benefits received by the other group participating in the market:
the producers. Producer surplus is the amount a seller receives for a product, minus its
cost. Graphically, the area below the price and above the supply curve measures the
producer surplus in a market. Also, note that an increase in the product’s price raises
producer surplus due to two reasons. First, existing sellers now receive more for their
product, and second, a higher price induces new sellers to enter the market. The concept of
producer surplus is a good measure of economic well-being of producers. The economic
well-being of society would be maximized by generating the most surplus for its two
groups—consumers and producers.
The next section examines why the free market is considered to be the best way to
maximize the sum of consumer and producer surplus in the economy.
4.2.1 Evaluating Market Equilibrium
Let us evaluate market equilibrium by highlighting important details from Chapter 7 in the
textbook (p. 157, Figure 7.7). This figure is reproduced below as Figure 4.1.
Figure 4.1: Con