Notesale: Turn your study into money

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Consumer Surplus
Consumer surplus is a measure of the benefit or welfare that consumers derive from consumption
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Consumer surplus is the area between the demand curve and the market price
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Consumers are willing to pay a high price for the first unit they buy
but a lower price for each extra unit they buy
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At the market price P* consumers buy Q* units of output so they spend a total amount equal to the
blue area
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Consumer surplus is
the difference between the two, the yellow area
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Consumer Surplus and An Increase in Demand

Consumer surplus is originally the orange and yellow areas
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The new consumer surplus is the red and orange areas
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Overall, consumer surplus increases because the gain in consumer surplus (the red area) is greater
than the loss in consumer surplus (the yellow area)
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Consumer Surplus and An Increase in Supply

Consumer surplus is originally the yellow area
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The

new consumer surplus is the yellow and orange areas
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Producer Surplus
Producer surplus is a measure of the benefit or welfare that producers derive from selling output
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Producer surplus is the area between the market price and the supply
curve
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Producers are willing to sell at a low price for the first unit but a
higher price for each extra unit they sell
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At the market price P* producers sell Q* units of output and producer surplus is the blue area
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Producer Surplus and An Increase in Supply

Producer surplus is originally the blue and purple areas
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The new producer surplus is the purple and green areas
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Overall,
producer surplus increases because the gain in producer surplus (the green area) is greater than the
loss in producer surplus (the blue area)
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Producer Surplus and An Increase in Demand

Producer surplus is originally the blue area
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The

new producer surplus is the purple and blue areas
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Consumer and producer surplus could be analyzed separately (as shown above) or together (as
shown below)
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An increase (decrease) in demand increases (decreases) both consumer and producer
surplus
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Producer surplus is originally the blue area
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The new consumer surplus is the red area
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Consumer surplus falls a bit because a higher
market price is paid but consumer surplus rises a lot because more is consumed
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The yellow area of lost
consumer surplus is transferred to producers
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A
government can use indirect taxes, subsidies, minimum and maximum prices to affect price and
output
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An indirect tax increases a producer’s costs
and causes a decrease in supply so the supply curve shifts left
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For example, a tax of £10
per unit
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A specific tax causes price to rise and output to fall
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For example, a tax of 20% on
price
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An ad valorem tax causes price to rise and output
to fall
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A specific tax raises revenue equal to the red
and blue areas
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But ‘tax shifting’ allows producers to make consumers pay some of the tax too
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A tax

essentially raises the price paid by consumers and lowers the price received by firms
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Producers absorb and pay the rest of the tax
equal to the blue area
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A more elastic (inelastic) supply causes taxes to fall more on the consumer (producer)
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Elastic Supply and Taxes

When supply is inelastic, consumers pay taxes equal to the red area, producers absorb the majority
of the tax and pay the blue area
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When demand is elastic, consumers pay taxes equal to the red area, producers absorb the majority
of the tax and pay the blue area
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Inelastic Demand and Taxes

Subsidies
A subsidy is a grant given by the government to producers to encourage the production of a good
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A subsidy causes price to fall and output to rise
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Subsidies

A subsidy benefits consumers because it lowers the market price and it benefits producers because
their costs fall
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Consumers receive the red area in subsidies because price is lower
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The total cost of the subsidy to the government is the red and
blue areas combined
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When demand is elastic, producers receive the majority of the subsidy equal to the blue area,
consumers receive a little bit of the subsidy equal to the red area
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Inelastic Demand and Subsidies



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