Consumer, Producer Surplus SFLS

Welfare Economics
Marginal Analysis
We will look at two concepts in this powerpoint:
Examination of the additional benefits of an activity
compared to the additional costs of that activity.
The use of Consumer and Producer surplus to see
how the allocation of resources affects economic
well-being. 资源的分配如何影响经济福祉

Welfare Economics
Marginal Analysis
We will look at two concepts in this powerpoint:
Examination of the additional benefits of an activity
compared to the additional costs of that activity.
The use of Consumer and Producer surplus to see
how the allocation of resources affects economic
well-being. 资源的分配如何影响经济福祉
This one first

1.) Resources are Scarce.
2.) Trade - Offs
3.) Opportunity Costs
4.) Marginal Thinking.
5.) Rational Thinking
6.) Specialization
- there is not enough stuff
for everyone.
- 鱼与熊掌不可兼得
- What you must give up when
you make a decision
- 最后的东西之一
- 合理的
- Productivity and the Division
of Labor
Basic ideas of Economics
And is one of the most
basic and important
principles for the whole
class.

How are prices
determined?
Short answer:
Market EQ

How are prices
determined?
Short answer:
On the Margins
深度分析 answer:
Market EQ

Coffee and Sugar pics of me
How is the price of coffee
determined?
This is the question we
answered before.

Coffee and Sugar pics of me
What is the value of it?
Now a slightly different
question…

What is the
value of it?
And not always an easy
one.

Example:
The Diamond / Water paradox 佯谬
Why is something like water that is needed
everyday to survive so cheap when diamonds
are so expensive.
This puzzled economists for hundreds of years
until it took a new revolution in thinking with
marginal analysis to figure this out and can be
explained with consumer surplus
Welfare Economics and Marginal Analysis

Another example:
Buying a car
This is something that is typically bargained
讨价还价 for, not everyone pays the same
price.
If you negotiate well you may buy a car for
less then you otherwise would be willing to
pay for it at the same time, the seller is trying
to sell it to you for the highest possible price.
Welfare Economics and Marginal Analysis

Means an additional one, the
measurement from one unit to the next.
最后的东西之一
Marginal Benefits VS. Marginal Costs
边际效益针对边际成本
(MB) (MC)
If MB > MC = It is worth doing 这是值得的
If MB = MC = It may be worth doing “a wash” 收支平衡
If MB < MC = Not worth doing 这是不值得的
Also called Cost/Benefit analysis
Marginal Thinking
This is probably the most useful
and important slide in the whole
class!

Means an additional one, the
measurement from one unit to the next.
最后的东西之一
Marginal Benefits VS. Marginal Costs
边际效益针对边际成本
(MB) (MC)
If MB > MC = It is worth doing 这是值得的
If MB = MC = It may be worth doing “a wash” 收支平衡
If MB < MC = Not worth doing 这是不值得的
Also called Cost/Benefit analysis
Marginal Thinking

– Training your brain to
understand value
训练你的大脑明白什么意思值
Supply and Marginal Cost
- Sellers distinguish 区别 between cost and price.
- Cost is what the seller gives up to
produce the good.
- Price is what the seller gets when the
good is sold.
- The cost of producing one
more unit of a good or
service is its marginal cost.
Marginal Cost
Marginal Thinking

– Training your brain to
understand value
训练你的大脑明白什么意思值
Marginal Benefit
Marginal Thinking
The value of one more unit of a good or service is
its marginal benefit. can be measured as the
maximum price that people
are willing to pay for
another unit of the good or
service.
Demand and Marginal Benefit
- Buyers distinguish 区别 between value and price.
- Value is what the buyer gets.
- Price is what the buyer pays.

Ex: Marginal Analysis
Cans of soda Total Utility
(U)
Marginal
Utility (MU)
Total Cost
(TC)
Marginal
Cost (MC)
0 0 0
1 5 1
2 8 2
3 10 3
4 11 4
5 11 5
6 4 6
The word “Utility” = Happiness (value)
Question is how
many cans of
soda to drink?

Cans of soda Total Utility
(U)
Marginal
Utility (MU)
Total Cost
(TC)
Marginal
Cost (MC)
0 0 0
1 5 1
2 8 2
3 10 3
4 11 4
5 11 5
6 4 6
The word “Utility” = Happiness (value)
Question is how
many cans of
soda to drink?
If MB > MC = keep
going!
If MB = MC = Perfect
amount!
If MB < MC = too
much!

Cans of Soda Total Utility
(U)
Marginal
Utility (MU)
Total Cost
(TC)
Marginal
Cost (MC)
0 0 -- 0 --
1 5 5 1 1
2 8 3 2 1
3 10 2 3 1
4 11 1 4 1
5 11 0 5 1
6 4 -7 6 1
The word “Utility” = Happiness
Find the MB and
the MC of each
can of soda.
If MB > MC = keep
going!
amount!
If MB < MC = too
much!

Cans of Soda Total Utility
(U)
Marginal
Utility (MU)
Total Cost
(TC)
Marginal
Cost (MC)
0 0 -- 0 --
1 5 5 1 1
2 8 3 2 1
3 10 2 3 1
4 11 1 4 1
5 11 0 5 1
6 4 -7 6 1
The word “Utility” = Happiness
4 cans is the best
amount!
If MB > MC = keep
going!
amount!
If MB < MC = too
much!

Efficiency - An allocation of resources is efficient if it
maximizes total surplus.
Efficiency means:
- The goods are consumed by the buyers
who value them most highly.
- The goods are produced by the
producers with the lowest costs.
- Raising or lowering the quantity of a
good artificially would not increase total
surplus.
Total Surplus = (value to buyers) – (cost to sellers)
Welfare Economics

Market EQ:
P = 30
Q = 15
Total surplus
= CS + PS
Is the market EQ efficient?
0
10
20
30
40
50
60
0 5 10 15 20 25 30
P
Q
S
D
CS
PS
D
S
Evaluating the Market Equilibrium (EQ)
So this is the goal
to understand.

Consumer Surplus
(CS)
Textbook Definition
The marginal benefit from a good or service minus
the price paid for it, summed over the quantity
consumed.
Easy Definition
The amount a buyer is willing to pay for a good
minus the amount the buyer actually pays for it.
Easiest Definition
CS = WTP – P
Welfare Economics

- Often we have things that mean a great deal to
us we say they are of sentimental value. 情感价值
- Maybe no amount of money might be able to
replace the object concerned.
Consumer Surplus
(CS)
CS = WTP – P
-In everyday life, however, we also place different
values on the things that we own. Consumer
surplus aims to assess 评估the value of these
items. This is a very important concept in
economic decision making.

Willingness to Pay
(WTP)
- A buyer’s willingness to pay for a good is the
maximum amount the buyer will pay for that good.
WTP measures how much the buyer values the
good.
name WTP
Peter 5250
Clara 4500
Wilson 3750
Key 3000
Example:
4 buyers’ WTP
for an iPad
Welfare Economics

Question:
If price of an iPad is 4500, who will buy an iPad, and
what is the quantity demanded?
Answer:
Peter & Clara will buy an iPod,
Wilson & Key will not.
Hence, Qd = 2
when P = 4500.
name WTP
Peter 5250
Clara 4500
Wilson 3750
Key 3000
WTP and the Demand Curve

Derive派生
the demand
schedule:
4
Peter, Clara,
Wilson, Key
0 – 3000
3
Peter, Clara,
Wilson
3001 – 3750
2Peter, Clara3751 – 4500
1Peter4501 – 5250
0nobody5251 & up
Qdwho buys
P (price
of iPad)
name WTP
Peter 5250
Clara 4500
Wilson 3750
Key 3000

0
750
1500
2250
3000
3750
4500
5250
6000
0 1 2 3 4
P Qd
6000 & up 0
4501 – 5250 1
3751 – 4500 2
3000 – 3750 3
0 – 3000 4
P
Q

About the Staircase Shape…
This D curve looks like a staircase
with 4 steps – one per buyer.
If there were a huge # of buyers,
as in a competitive market,
there would be a huge #
of very tiny steps,
and it would look
more like a smooth
curve.0
750
1500
2250
3000
3750
4500
5250
6000
0 1 2 3 4
P
Q

If we looked at a larger
market with many more
buyers, each would be a
step on this curve
It looks just like a demand
curve doesn’t it
That’s because it is!
D = MB0
750
1500
2250
3000
3750
4500
5250
6000
0 100200300400500
P
Q
Demand = Marginal Benefit
About the Staircase Shape…

0
750
1500
2250
3000
3750
4500
5250
6000
0 1 2 3 4
At any Q,
the height of
the D curve is the WTP of
the marginal buyer, the
buyer who would leave the
market if P were any
higher.
Peters’s WTP
Clara’s WTP
Wilson’s WTP
Key’s WTP
P
Q

is the amount a buyer is willing to pay minus the
amount the buyer actually pays:
name WTP
Peter 5250
Clara 4500
Wilson 3750
Key 3000
Suppose P = 4600.
Only Peter will buy it
Peter’s CS = 5250 – 4600 = 650.
The others get no CS because
they do not buy an iPad at this
price.
Total CS = 650.
Consumer Surplus
(CS)
CS = WTP – P
Example:

0
750
1500
2250
3000
3750
4500
5250
6000
0 1 2 3 4
P
Q
Peter’s WTP
P = 4600
Peter’s CS =
5250 – 4600 = 650
Total CS = 650
CS and the Demand Curve

0
750
1500
2250
3000
3750
4500
5250
6000
0 1 2 3 4
P
Q
Peter’s WTP
Clara’s WTP
Instead, suppose
P = 3800
Peter’s CS =
5250 – 3800 = 1450
Clara’s CS =
4500 – 3800 = 700
Total CS = 2150

0
750
1500
2250
3000
3750
4500
5250
6000
0 1 2 3 4
P
Q
The lesson:
Total CS equals
the area under
the demand curve
above the price,
from 0 to Q.

0
10
20
30
40
50
60
0 5 10 15 20 25 30
P
Q
The demand for shoes
D
Number of
buyers
Price
per KG
At Q = 5, the
marginal buyer is
willing to pay 50 for
a Kg of tea.
Suppose P = 30.
Then his consumer
surplus = 20.

0
10
20
30
40
50
60
0 5 10 15 20 25 30
P
Q
The demand for shoes
D
CS is the area b/w P
and the D curve,
from 0 to Q.

0
10
20
30
40
50
60
0 5 10 15 20 25 30
P
Q
D
If P rises to 40,
CS falls
Two reasons for the
fall in CS.
1. Fall in CS
due to buyers
leaving market
2. Fall in CS due to
remaining buyers
paying higher P
Higher Prices Reduce CS

Now for the Producer’s side
It’s basically the same thing for the other guys
too, just a little different vocabulary so I will go
though it faster

Producer Surplus
(PS)
Textbook Definition
The marginal benefit from a good or service minus
the cost to produce it, summed over the quantity
sold.
Easy Definition
The amount a seller is willing to sell a good minus
the amount the buyer actually pays for it.
Easiest Definition
PS = WTS – P
Welfare Economics

name cost
Tom 10
Jim 20
Andy 35
A seller will produce and sell the
good/service only if the
price exceeds his or her cost.
Hence, cost is a measure of
Willingness to Sell.
- is the value of everything a seller must give up to produce
a good (i.e., opportunity cost).
- Includes cost of all resources used to produce good,
including value of the seller’s time.
Welfare Economics
Cost
Example:
Costs of 3 sellers in the tea selling
business.

335 & up
220 – 34
110 – 19
00 – 9
QsP
Derive 派生 the supply
schedule from the cost
data:
name cost
Tom 10
Jim 20
Andy 35
Cost and the Supply Curve

$0
$10
$20
$30
$40
0 1 2 3
P
Q
P Qs
0 – 9 0
10 – 19 1
20 – 34 2
35 & up 3
name cost
Tom 10
Jim 20
Andy 35

$0
$10
$20
$30
$40
0 1 2 3
P
Q
At each Q,
the height of
the S curve is the cost of the
marginal seller,
the seller who would leave
the market if the price were
any lower.
Andy’s
cost
Jim’s
cost
Tom’s cost

$0
$10
$20
$30
$40
0 1 2 3
P
Q
Producer surplus (PS):
the amount a seller
is paid for a good
minus the seller’s cost
PS = P – cost
Producer Surplus (PS)

$0
$10
$20
$30
$40
0 1 2 3
P
Q
PS = P – cost
Suppose P = 25.
Tom’s PS = 15
Jim’s PS = 5
Andy’s PS = 0
Total PS = 20
Jim’s
cost
Toms cost
Total PS equals the
area above the supply
curve under the price,
from 0 to Q.
Andy’s
cost
Producer Surplus (PS) and the Supply Curve

0
10
20
30
40
50
60
0 5 10 15 20 25 30
P
Q
S
Number of
buyers
Price
per KG
Suppose P = 40.
At Q = 15, the
marginal seller’s cost
is 30,
and her producer
surplus is 10.

0
10
20
30
40
50
60
0 5 10 15 20 25 30
P
Q
The supply of shoes
S
PS is the area b/w
P and the S
curve, from 0 to
Q.

0
10
20
30
40
50
60
0 5 10 15 20 25 30
P
Q
If P falls to 30,
PS falls
Two reasons for the fall
in PS.
S
1. Fall in PS
due to sellers
leaving market
2. Fall in PS due to
remaining sellers
getting lower P
Lower Prices Reduces (PS)

CS = (value to buyers) – (amount paid by buyers)
= buyers’ gains from participating in the market
PS = (amount received by sellers) – (cost to sellers)
= sellers’ gains from participating in the market
Total surplus = CS + PS
= (value to buyers) – (cost to sellers)
= total gains from trade in a market
(PS) (CS) and Total Surplus

Market EQ:
P = 30
Q = 15
Total surplus
= CS + PS
Is the market EQ efficient?
0
10
20
30
40
50
60
0 5 10 15 20 25 30
P
Q
S
D
CS
PS
D
S
Evaluating the Market Equilibrium (EQ)
So yes! This is as
good as it gets!

Which Buyers Consume the Good?
0
10
20
30
40
50
60
0 5 10 15 20 25 30
P
Q
S
D
Every buyer
whose WTP is ≥ 30 will buy.
D

0
10
20
30
40
50
60
0 5 10 15 20 25 30
P
Q
S
D
Every buyer
whose WTP is < 30 will not.
D

0
10
20
30
40
50
60
0 5 10 15 20 25 30
P
Q
S
D
Every buyer
whose WTP is ≥ 30 will buy.
Every buyer
whose WTP is < 30 will not.
So…
D
the buyers who
value the good
most highly are the
ones who
consume it.

Which Sellers Produce the Good?
0
10
20
30
40
50
60
0 5 10 15 20 25 30
P
Q
S
D
Every seller whose
cost is ≤ 30 will
produce the good.
S

0
10
20
30
40
50
60
0 5 10 15 20 25 30
P
Q
S
D
Every seller whose
cost is > 30 will not.
S

0
10
20
30
40
50
60
0 5 10 15 20 25 30
P
Q
S
D
Every seller whose
cost is ≤ 30 will
produce the good.
Every seller whose
cost is > 30 will not.
So…
S
the sellers with
the lowest cost
produce the
good.

0
10
20
30
40
50
60
0 5 10 15 20 25 30
P
Q
S
D
At Q = 10,
cost of producing
the marginal unit
is 25
value to consumers
of the marginal unit
is 40
Hence, can increase total surplus
by increasing Q.
This is true at any Q less than 15.
Does EQ Maximize Total Surplus?
S
D

0
10
20
30
40
50
60
0 5 10 15 20 25 30
P
Q
S
D
At Q = 20,
cost of producing
the marginal unit
is 35
value to consumers
of the marginal unit
is only 20
Hence, can increase total surplus
by reducing Q.
This is true at any Q greater than
15.
S
D

0
10
20
30
40
50
60
0 5 10 15 20 25 30
P
Q
S
D
CS
PS
D
SThe market
EQ quantity maximizes
total surplus:
At any other quantity,
can increase
total surplus by moving
toward
the market EQ quantity.

“Free” Market Equilibrium (EQ) is
the most efficient way to produce
the things that society needs, wants,
and thinks it wants.
End of story.
And the answer on any test about it
Positive economics
is the study of what is
结果是基于数据
Normative economics
is the study of what should be
是基于你的愿望是什么结果

This system is really good
but isn’t always equal and
fair to everyone…

Some people do
very well in this
system.

As well as some
other unintended
problems…

The short answer is
no, Humans haven’t
figured out a better
system this this so far.

Consumer, Producer Surplus SFLS

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