If you were willing to pay $1000 to buy all my books and I allowed you to buy them for just 20 dollars, $980 would be your consumer surplus. Consumer surplus is the money you save from paying less than the maximum price you are willing to pay.
Now say your punk ass got my books for 20 dollars, and immediately sold them for $2,000. $1,980 would be your producer surplus. Producer surplus is the money you earn from selling a product for more than the minimum price you are willing to sell it for.
Together, they are known as economic surplus. This is a natural part of most markets because there’s rarely a price that’s simultaneously the minimum producers are willing to sell for and the maximum consumers are wiling to buy for. If I was willing to sell you a high five for a minimum of $50 and you were willing to buy it for a maximum of $50, in that case, there would be no economic surplus; but other than that example, it wouldn’t happen often.
For the 6th chocolate bar, consumers are willing to pay $1.50. For the 11th bar, they are willing to pay $1.25. But because of the market price of $1.00, consumers get a surplus for each of those units (50 cents and 25 cents respectively).
The total consumer surplus here is represented by the sum of the surplus of each chocolate bar, or in other words, the area of the top triangle. The area of any triangle is base times height divided by 2, so 16 units times 75 cents, which is 12 dollars, divided by 2 is 6 dollars. 6 dollars is the total consumer surplus. This is the total money consumers were willing to pay but didn’t have to pay. This is above the 16 units for $1 each, or $16 they did pay.
Producer surplus is calculated in a similar way (it’s the area of the bottom triangle).
Okay, before you consummate your plot of murdering me for using so much Math, I will now get to my point. Note how in the market I made up, consumer and producer surplus are even under perfect competition. Now watch what happens when I turn the same market into a monopoly.
See that, not only does society lose economic surplus (noted by the triangle representing the deadweight loss), the monopoly also takes a greater share of the remaining economic surplus. Before, by paying $16 for 16 chocolate bars, consumers got 6 dollars of surplus. Under a monopoly, by paying $13.75 for 11 chocolate bars, they only get $2.75 of surplus.
Less surplus means less money the consumer can spend on other goods, which means they won’t be able to buy my books. :/ Oh, and that they’re less happy. I guess that’s sad too.
In order to give consumers some relief, a government might enforce a price ceiling. A price ceiling is the maximum price a firm is allowed to sell a good or service for, by law. Like any government policy however, this act can have unintended consequences, in particular, when the price ceiling falls below equilibrium price. Take the case of rent control for example, where governments enforce a maximum rent tenants have to pay for certain apartments.
The first thing you may notice from looking at the graph is that consumer surplus has increased per apartment rented, meaning the tenants who have them are probably very happy. But that’s not the only story this graph is telling.
In this market, only, 1,100 apartments are rented out, even though without the price ceiling, 1,600 would be rented. Those 500 other apartments either weren’t rented because the owners had something more profitable to use the space for or they didn’t bother building the apartments in the first place because they had a more profitable venture to invest in (opportunity costs are included in the marginal cost curve). There is thus under-production of available apartments.
Even more, notice how the demand line shows that 2,100 people are willing to rent the apartments at this price; but there are only 1,100 apartments available based on the supply line. Where will those 1000 other people go? Well, first they’ll try to compete with the 1,100 other people, creating an inefficient process with long lines and waiting lists. After they’re rejected, they’ll join the markets for more expensive apartments, and the increased demand in those markets will cause a further increase in already expensive rents. So while the price is artificially kept low in rent-controlled markets, prices will rise naturally in other apartment markets.
So while the tenants who get these rent-controlled apartments will be happy with all the money they’re saving, they would be hurting the rest of society.
Note: Rent control could be a means to alleviate the most crippling forms of poverty. So while there may be a social concern of inefficient allocation as well as price distortion, as a victim of this stupid emotion liberals call empathy, I personally support rent control. Especially for struggling families with innocent children. But who gives a shit what my humanitarian opinion is, your evil ass is only here to learn Economics.
To the people without evil asses, I love you. Now go buy my books.
Sometimes a government will try to give producers some relief by implementing a price floor, i.e. a minimum price consumers have to pay. An often talked about example of this is when governments enforce a minimum wage.
As you would expect, there is higher economic surplus per worker when there’s a price floor. But there are fewer workers employed. There will be more workers who want the jobs than there are positions available, creating unemployment, as well as lower wages in other sectors of the economy.
There’s also the concern that workers would be replaced by more cost-effective machines.
Ironically, even though this model predicts that minimum wage would lead to more unemployment, it doesn’t always play out that way in reality. There have been several studies on hikes which have shown that increases in minimum wage often have no effect or a negligible effect on employment.
This doesn’t necessarily mean that the model is wrong; it could just mean that there are other factors at play. For example, minimum wage historically has only increased in small increments to keep up with inflation. There has never been a 15 dollar hike in the minimum wage, making it difficult to discern the effect of a minimum wage hike (since there may be stronger forces causing market equilibrium to slightly rise or fall). There’s also the possibility that companies today have a lot of inefficiency in them, where workers on the bottom are not given as much responsibilities as they can handle. A slight minimum wage increase may encourage employers to expect a little more out of their employees so that they get what they paid for. Perhaps if minimum wage was doubled over one year, the unemployment effect would be more apparent then.
I’m probably breaking a lot of partisan hearts with my build-it-up-first-tear-it-down-later assessments. Sorry about that. If you want revenge, maybe you can share this page on your Facebook in front of all your friends, and say something like “fuck this guy!” I am not telling you that just so I would get more website views… Like why would I do that?
I’ve been drawing perfect competition markets in a way where producer and consumer surplus are the same. I was deceiving you. In reality, the slopes of supply and demand can vary, and it could mean different things for producer and consumer surplus.
If a good is a luxury, then demand would be elastic, resulting in lower consumer surplus.
If a good is a necessity, then demand would be inelastic, resulting in higher consumer surplus.
If mass producing and selling a good is easy, then supply would be elastic, resulting in lower producer surplus per unit.
If mass producing and selling a good is difficult, then supply would be inelastic, resulting in higher producer surplus per unit.
In case you didn’t follow all that, remember that when something is elastic, its slope is flatter. When something is inelastic, its slope is steeper.
Figure out the effects of a consumption tax and an income tax on economic surplus. Use the Supply and Demand course to see how taxes shift supply and demand as a hint, you cheater. I will not check if you do the homework since that apparently makes me a cool teacher.
<- Back (A. How does competition affect pricing?)(C. How do opportunities and preferences determine Economic choices?) Forward ->