01/22 Chapter 4
Willingness to Pay and Consumer Surplus:
Individual consumer surplus: The net gain that a buyer achieves from the purchase
of a good. (Difference between the willingness to pay and the actual price paid).
Total consumer surplus: the sum of the individual consumer surplus achieved by all
buyers of a good.
Consumer surplus often used to refer both individual and total consumer surplus.
4-2: The total consumer surplus generated by purchases of a good at a given price is
equal to the area below the demand curve but above that price.
How changing the price affects consumer surplus:
Producer Surplus and Supply Curve: 01/22 Chapter 4
Seller’s cost: the lowest price at which he or she is willing to sell their good. (The real
cost of something is what you must give up to get).
Individual Producer Surplus: the net gain to an individual seller from selling a good.
Equal to the difference between the price received and the seller’s cost. (Minimum price
in which he is willing to sell)
Total Producer Surplus: the total net gain to all sellers in the market. (Sum of
individual surpluses) 01/22 Chapter 4
. While a fall in price increases consumer surplus, it reduces producer surplus. And a
rise in price reduces consumer surplus but increases producer surplus.
(Supply counterpart for 4-5)
Gains from Trade:
Total surplus: the net gain from adding consumer surplus and producer surplus
together. 01/22 Chapter 4
Efficiency of Markets: (We claim markets are usually efficient and once market has
produced gains from trade, there’s no way to make some people better off without
making others worst off).
3 Ways in which the committee can increase the total surplus:
1. Reallocate consumption among consumers
a. Selling to different consumers.
i. BUT = take book away from a student who values it more and
giving it to someone who values it less. Reducing the total
2. Reallocate sales among sellers
a. Altering who sells their books, take away those who sell at
market equilibrium instead of compelling those who would not have sold
their books at market equilibrium.
3. Change the quantity traded
a. Trade more books for fewer books than
The key point to remember is that once this market is in
equilibrium, there is no way to increase the gains from
We can summarize our results by stating that an
efficient market performs four important functions:
1. It allocates consumption of the good to the potential
buyers who most value it, as indicated by the fact that
they have the highest willingness to pay.
2. It allocates sales to the potential sellers who most value the right to sell the good, as
indicated by the fact that they have the lowest cost.
3. It ensures that every consumer who makes a purchase values the good more than
every seller who makes a sale, so that all transactions are mutually beneficial.
4. It ensures that every potential buyer who doesn’t make a purchase values the good
less than every potential seller who doesn’t make a sale,so that no mutually beneficial
transactions are missed.
As a result of these four functions, any way of allocating the good other than the market
equilibrium outcome lowers total surplus.
There are three caveats (warnings 01/22 Chapter 4
1. Market may be efficient, but it