Consumer & Producer Surplus (AQA A Level Economics)

• Market efficiency and welfare losses in market structures can be considered through the concepts of consumer and producer surplus
   

• Consumer surplus is the difference between the amount the consumer is willing to pay for a product and the price they have actually paid
  • E.g. If a consumer is willing to pay £18 to watch a movie and the price is £15, their consumer surplus is £3
    
    
• Producer surplus is the difference between the amount that the producer is willing to sell a product for and the price they actually do
  • E.g. If a producer is willing to sell a laptop for £450 and the price is £595, their producer surplus is £145

Diagram: Consumer and Producer Surplus

Consumer surplus lies below the demand curve and producer surplus lies above the supply curve

Diagram analysis

• The area between the equilibrium price and the demand curve represents the consumer surplus in the market (ABP_e)
  • The consumer surplus lies underneath the demand curve
     
• The area between the equilibrium price and the supply curve represents the producer surplus in the market (CBP_e)
  • Producer surplus lies above the supply curve
    
    
• When the market is at equilibrium, producer and consumer surplus are maximised
• Consumer surplus + producer surplus = social/community surplus
  • Any disequilibrium reduces the social surplus

• Monopoly is typically compared to perfect competition when comparing market efficiency 
  • Due to the lack of competition, monopolies tend to have higher prices and lower output
  • As a result, they have lower levels of consumer surplus and higher levels of producer surplus

Diagram: Consumer and Producer Surplus in a Monopoly

The Monopolist sells at higher price P₂ and restricts output to Q₁

Diagram analysis

Change to consumer surplus

• The monopolist produces at the profit maximisation level of output Q2, where MC=MR (A) and sells their products at a monopoly price of P₂
• In a more competitive environment, such as a monopolistic market, consumers would pay the lower price P₁ where AR=MC (allocative efficiency)
• The loss of consumer surplus due to the monopoly price is equal to shaded triangle - DBC

Change to producer surplus

• Producer surplus is maximised at the profit maximisation level of output (Q₂)
• Compared with monopolistic firms, as quantity falls from Q1 to Q2, there is a loss of producer surplus equal to the shaded triangle (DCA)
• However, at the same time, some of the previous consumer surplus is converted to producer surplus (P₁P₂BD), resulting in a net gain of producer surplus
  
  
• The welfare loss is equal to the area of the shaded triangle - ADC
  • The cost to society caused by a lack of efficiency in the allocation of resource

• Price discrimination may increase consumer surplus in lower priced markets and decrease consumer surplus in higher price markets 

Diagram: Consumer Surplus and Price Discrimination in Monopoly

Price discrimination based price inelastic (peak travel) & price elastic demand (off-peak travel)

Diagram explanation

• Each train route has an effective monopoly provider
• The overall firm is producing at the profit maximising level of output where MC=MR
  • This point is extrapolated to both market segments on the left by using the lower dotted line
  • The average cost is extrapolated across both sub-markets using the upper dotted line (C₁)

• A higher price for peak travel has been set at P_a & a lower price for off-peak travel has been set at P_b

Diagram: Consumer Surplus and Price Discrimination in Monopoly

Price discrimination is evident from the price inelastic (peak travel) & price elastic demand (off-peak travel)

Diagram analysis

• Each train route in the UK has an effective monopoly provider
• The overall firm is producing at the profit maximising level of output, where MC=MR
  • This point is extrapolated to both market segments on the left by using the lower dotted line
  • The average cost is extrapolated across both sub-markets using the upper dotted line (C₁)
     

• A higher price for peak travel has been set at P_a  and a lower price for off-peak travel has been set at P_b

Consumer surplus in the peak period

• Consumer surplus decreases 
  • There is a reduction in consumer surplus for the peak travel (inelastic) market as consumers pay a higher price
    • The consumer surplus in this market is shaded in yellow

Consumer surplus in the off peak period

• Consumer surplus increases 
  • There is an increase in consumer surplus for the off peak travel (elastic) market as consumers pay a lower price
    • The consumer surplus in this market is shaded in yellow

Overall Consumer Surplus

• • Price discrimination causes the overall producer surplus to increase
  • This means that the overall consumer surplus is decreasing
  • Some consumers will benefit and others will lose out, but the end result is that the overall consumer surplus will fall