Chapter 15 Consumer surplus and producer surplus

Chapter 15 Consumer surplus and producer surplus

I. The concept of consumer surplus (P.2 – 9)

A. Benefit from consumption

1. The benefit from consuming a good reflects

- the ___maximum___ amount of ___other goods___ that a consumer is

___willing to give up____ for the good.

- the ___maximum___ amount of ___money___ that a consumer is

___willing to pay____ for the good.

- the __maximum demand-price___.

2. The benefit from consumption can be measured by

a) the total benefit (TB), i.e., the consumers’ maximum willingness to pay for

___a given quantity of a good______.

b) the marginal benefit (MB), i.e., the consumer’s maximum willingness to

pay for ___an extra unit of a good_____. Economists assume that the

marginal benefit is __decreasing___ as a consumer consumes more of a

good.

c) the average benefit (AB), i.e., the consumer’s maximum willingness to pay

for ___a unit of a good on average____.

Exercise 1: The relationship between TB, MB & AB (Book 3, P.5)

1. Fill in the blanks in the following table:

Quantity

(units/week)Total benefit ($) Marginal benefit ($) Average benefit ($)

1 10 __10 – 0 = 10__ __10 1 = 10__

KCC(ST) F.5 Economics Ch.15–P.1

2 __10 + 9 = 19__ 9 __19 2 = 9.5__

3 __9 3 = 27__ __27 – 19 = 8__ 9

4 34 __34 – 27 = 7__ __34 4 = 8.5__

5 __34 + 6 = 40__ 6 __40 5 = 6__

2. How can we find

a) TB from AB? TB = ___AB Q__

b) TB from MB? TB = _____ MB_____

c) AB from TB? AB = ___TB Q__

d) MB from TB? MB = __ TB Q__

B. MB = P maximization of consumer surplus

1. Consumer surplus

- is the concept we use to measure a consumer’s gain from __market

exchange_.

- is the extra amount a consumer ___is willing to pay__ above what he

__actually pays___.

- is the difference between __total benefit___ and __total expenditure___.

2a) If P __<__ MB (say, at 1st plate of sushi), the consumer can gain more

consumer surplus by _ in creasing consumption. This is because the

__benefit___ from consuming the additional units is more than what

he has to pay for them.

MB of additional plate of sushi ($)

MB

25

20

15

10

5

0 1 2 3 4 5 Quantity of sushi


P = $15

Increase in CS when consumption of sushi is increased from 1 plate to 3 plates.

b) If P __ > __ MB (say, at the 5th plate of sushi), the consumer can gain more

consumer surplus by _ de creasing consumption. This is because the saving

in expenditure is more than the loss in ___benefit___ of NOT consuming

those units.


MB

25

20

15

10

5


c) When a consumer consumes up to the point where his ___marginal benefit___

is equal to the ___market price___, his consumer surplus is maximized.


MB

25

20

15

10

5


3. Derivation of the demand curve from the MB curve:

Given the price of a good, we can find its ___quantity demanded___ from the

marginal benefit (MB) curve by finding the quantity where ___MB = price__.

Therefore, the MB curve is actually the demand curve, which relates __price__

and __quantity demanded___.


P = $15

Increase in CS when consumption of sushi is decreased from 5 plates to 3 plates.

P = $15

Consumer surplus is maximized when MB = P

$

MB curve

P1=MB1

P2=MB2

0 Q1 Q2 Q

$

demand curve = MB curve

0 Q1 Q2 Q

Exercise 2: The concept of consumer surplus (Book 3, P.9)

Complete the following table:

Price

($)

Quantity

demanded

(units /week)

Marginal

benefit

(MB) ($)

Total benefit

(TB) ($)

Total

expenditure

(TE) ($)

Consumer

surplus ($)

5 1 __5__ ____5____ __5 1 = 5__ __5 – 5 = 0__

4 2 __4__ _5 + 4 = 9__ __4 2 = 8__ _ 9 – 8 = 1__

3 3 __3__ _9 + 3 = 12__ __3 3 = 9__ _12 – 9 = 3__

2 4 __2__ _12 + 2 = 14__ __2 4 = 8__ _14 – 8 = 6__

1 5 __1__ _14 + 1 = 15__ __1 5 = 5__ _15 – 5 = 10__

II. The concept of producer surplus (P.9 – 15)

A. Cost of production

1. The cost of producing a unit of good reflects

- the ___minimum___ amount of ___money___ that a producer

___must receive____ in order to produce that unit of the good.

- the __minimum supply-price___.

2. The cost of production can be measured by


a) the total cost (TC), i.e., the cost of producing ___a given quantity of a

good______.

b) the marginal cost (MC), i.e., the cost of producing ___an extra unit of a

good_____.

In the short run, total cost (TC) = ___total fixed cost (_TFC_) _+ total

variable cost (_TVC_) . Since T_F_C remains unchanged when output is

increased, the change in TC is equal to the change in T_V_C, so marginal

cost is equal to marginal __variable___ cost.

c) the average cost (AC), i.e., the cost of producing ___a unit of a good on

average____.

Exercise 3: The relationship between TC, MC & AC (Book 3, P.13)

1. Fill in the blanks in the following table:

Quantity

(units/week)Total cost ($) Marginal cost ($) Average cost ($)

1 3 __3 – 0 = 3__ __3 1 = 3__

2 __3 + 5 = 8__ 5 __8 2 = 4__

3 __5 3 = 15__ __15 – 8 = 7__ 5

4 24 __24 – 15 = 9__ __24 4 = 6__

5 __24 +11 = 35__ 11 __35 5 = 7__

2. How can we find

a) TC from AC? TC = ___AC Q__

b) TC from MC? TC = ___ MC + TFC_

c) AC from TC? AC = ___TC Q__

d) MC from TC? MC = __ TC Q__

B. MC = P maximization of producer surplus

1. Producer surplus

- is the concept we use to measure a producer’s gain from __market


exchange_.

- is the extra amount a producer ___actually receives____ above the

__minimum amount he must receive____.

- is the difference between __total revenue___ and __total variable cost__.

2a) If P __>__ MC (say, at 1st plate of sushi), the producer can gain more producer

surplus by _ in creasing production. This is because the producer can get a price

that is more than enough to cover his cost of producing extra units.

MC ($)

25 MC

20

15

10

5


b) If P _<__ MC (say, at the 5th plate of sushi), the producer can gain more

producer surplus by _ de creasing production. This is because the saving in cost

is more than the loss in revenue of NOT producing those units.

MC ($)

25 MC

20

15

10

5


c) When a producer produces up to the point where his ___marginal cost__ is

equal to the __market price__, his producer surplus is maximized.


P = $15

P = $15

Increase in PS when production of sushi is increased from 1 plate to 3 plates.

Loss in PS avoided when production of sushi is decreased from 5 plates to 3 plates.

MC ($)

25 MC

20

15

10

5


3. Derivation of the supply curve from the MC curve:

Given the price of a good, we can find its ___quantity supplied___ from the

marginal cost (MC) curve by finding the quantity where ___MC = price__.

Therefore, the MC curve is actually the supply curve, which relates __price__

and __quantity supplied___.

$

MC curve

P2 = MC2

P1=MC1

0 Q1 Q2_ Q

$

Supply curve = MC curve

0 Q1 Q2 Q

Exercise 4: The concept of producer surplus (Book 3, P.15)

Complete the following table:

Price

($)

Quantity

supplied

(units /week)

Marginal

cost

(MC) ($)

Total variable

cost (TVC) ($)

Total revenue

(TR) ($)

Producer

surplus ($)

1 1 __1__ ____1____ __1 1 = 1__ __1 – 1 = 0__

2 2 __2__ _1 + 2 = 3__ __2 2 = 4__ _ 4 – 3 = 1__

3 3 __3__ _3 + 3 = 6__ __3 3 = 9__ __9 – 6 = 3__

4 4 __4__ _6 + 4 = 10__ __4 4 = 16__ _16 – 10 = 6__


P = $15

Producer surplus is maximized when MC = P

5 5 __5__ _10 + 5 = 15__ __5 5 = 25__ _25 – 15 = 10

III. Total gain from market exchange (P.16 – 18)

A. Total social surplus

- is the concept we use to measure the total gain from __market exchange_

for consumers and producers.

- is the sum of __consumer surplus___ and __producer surplus__.

B. MB = MC maximization of total social surplus

1. When __MB > MC_, there is a potential gain (= __marginal social surplus__ )

from further market exchange because consumers’ maximum willingness to pay

is more than producers’ minimum supply-price.

2. Total social surplus is maximized when ____MB = MC___.

$

D = MB S = MC

Pe

0 Qe Q

Exercise 5: The concept of total social surplus

Refer to Book 3, p.18 for Question 1 and p.15 Discuss 15.2 for Question 2.

1.Quantity

(units /week)MB ($) MC ($)

Marginal social

surplus ($)

Total social surplus

($)

1 8 1 __8 – 1 = 7__ __0 7 = 7__


CS

PS

2 7 2 _ 7 – 2 = 5__ __7 5 = 12__

3 6 3 __6 – 3 = 3__ __12 3 = 15__

4 5 5 _5 – 5 = 0__ __15 0 = 15__

5 4 8 _4 – 8 = -4__ __15 (-4) = 11__

2. It is / is not correct to say that bookstores gain at the expense of consumers. As

both consumers and bookstores ___voluntarily___ engage in buying and selling,

they must expect __a gain __ from the transactions. Consumers can gain because

____the prices they pay are lower than the maximum they are willing to

pay_________. Bookstores gain because __the prices they receive are higher

than their costs of supplying the books.______________

IV. Changes in consumer surplus, producer surplus & total social surplus (P.16–18)

1. Effect of a decrease in demand on CS, PS & TSS

c) $

S = MC

P1

P2

D2 = MB2 D1 = MB1

0 Q2 Q1 Q


original consumer surplus new consumer surplus

original producer surplus new producer surplus

original total social surplus new total social surplus


2. Effect of a decrease in supply on CS, PS & TSS

c) $ S2 = MC2

S1 = MC1

P1

D = MB

0 Q2 Q1 Q


P2

original consumer surplus new consumer surplus

original producer surplus new producer surplus

original total social surplus new total social surplus


Textbook Chapter end Exercises: (P.23 – 26)

Multiple Choice questions

1. (B), (D) The market price of a good is the same as the price actually paid for

the good / the maximum price one is willing to pay for the good .

(C) _Consumer surplus_____ obtained from consuming one more unit of a

good = the maximum price a consumer is willing to pay for that unit of the good

(i.e., the __benefit___ of that unit of a good to a consumer) – the price the

consumer actually pays for that unit of a good.

So the answer is ___A___.

2. (A) Total benefit = the maximum willingness to pay for a given quantity / an

additional unit of a good.

(B) Average benefit = the maximum willingness to pay for a good on average /

at the margin .

(C) Market price = the price / maximum price a consumer actually pays / is

willing to pay for a good.

So the answer is ___C___.

3. Economics assumes that the marginal benefit of a good decreases / increases /

remains unchanged when more of the good is consumed.


4. (B) If the price is lower than the ___marginal cost___, the producer cannot

gain from the exchange.

(C) Both the producer and the consumer can gain from the exchange if the price

is higher than the producer’s _____marginal cost_____ but lower than the

consumer’s __marginal benefit__ .

(D) If marginal benefit > price, an increase / a reduction in consumption can

increase consumer surplus and hence total social surplus. So total social surplus

will not be maximized when MB > P.



5. Consumer surplus

= total ___benefit___ – total __expenditure___

= total ___benefit___ – (__market price____ __quantity demanded_)

So the answer is ___D___.

6. Consumer surplus

= the maximum price John is willing to pay for the car – the actual price he pays for the car

= $ (__20 000 – 19 000__ )


7. Producer surplus

= total ___revenue___ – total __variable cost___

= (P – MC for the 1st unit) + (P – MC for the 2nd unit) + … (P – MC for the nth unit)

So the answer is ___C___.8. Producer surplus

= the actual price Paul receives for the flat – the minimum price Paul must receive for the flat

= $ (__3.2 million _ – _3 million_ )

So the answer is ___B___.

9. Consumer surplus = Area ___A___

Producer surplus = Area ___B___

Total social surplus = Consumer surplus + Producer surplus = Area _A_+ B__

Total expenditure = Total revenue = Area ___B_+ C__


Short Questions


1. Agree / Disagree .

Whenever __the marginal benefit is higher than the price__(_MB > P__),

Sue, being a rational consumer, will buy more of a good to increase her

consumer surplus.

Whenever ____MB <__P____, Sue, being a rational consumer, will buy less of

the good.

Therefore, given Sue’s MB curve is decreasing / downward-sloping , Sue

will consume up to the point where __the marginal benefit for the last unit of

the good is equal to the price she actually pays for that unit of the good.

2. Given the price of a good, we can find its ___quantity demanded___ from the

marginal benefit (MB) curve by finding the quantity where ___MB = price__.

Therefore, the MB curve is actually the demand curve, which relates __price__

and __quantity demanded___.

$

MB curve

P1 = MB1

P2=MB2

0 Q1 Q2_ Q

$

demand curve = MB curve

0 Q1 Q2_ Q

3. Given the price of a good, we can find its ___quantity supplied___ from the

marginal cost (MC) curve by finding the quantity where ___MC = price__.

Therefore, the MC curve is actually the supply curve, which relates __price__

and __quantity supplied___.


$

MC curve

P2=MC2

P1=MC1

0 Q1 _Q2 Q

$

Supply curve = MC curve

0 Q1 Q2_ Q

4a) Consumer surplus

= the maximum price Peter is willing to pay for the book – the actual price he pays for it

= $ (_100 – 100 __90%__ )

= $__10__

b) Producer surplus

= the actual price the seller receives for the book – the minimum price the seller must receive

to cover his variable cost

= $ (_100 __90%_ – _ 100 __70% )

= $__20__

5a) Equilibrium price = $__6__ & equilibrium quantity = __3__ units

b)Quantity

(units/week)

Marginal

benefit

(MB)

Marginal

cost

(MC)

Marginal

social surplus

(MSS)

Total social

surplus

MSS

Consumer

surplus

MB–TE

Producer

surplus

TR - MC

1 $10 $2$(10 – 2)

= $_8_$8

$(10 – 6)

= $_4_

$(6 – 2)

= $_4_

2 $8 $4$(8 – 4)

= $_4_

$(8 + 4)

= $_12_

$(18 – 12)

= $_6_

$(12 – 6)

= $_6_

3 $6 $6$(6 – 6)

= $_0_

$(12 + 0)

= $_12_

$(24 – 18)

= $_6_

$(18 – 12)

= $_6_

4 $4 $8$(4 – 8)

= _-$4_

$(12 – 4)

= $_8_

$(28 – 24)

= $_4_

$(24 – 20)

= $_4_

5 $2 $10 $(2 – 10) $(8 – 8) $(30 – 30) $(30 – 30)


= _-$8_ = $_0_ = $_0_ = $_0_

Structured Questions

1a) P S

0 no. of visitors b) HK has excess capacity during off-

peak seasons because the price is

_above the equilibrium level when

the ___demand__ is much lower

during the off-peak seasons.

P S

D

P1

0 Qd Qs No. of

excess supply visitors

c) Suppose the original price of each

visit is P1. After paying a lump

sum for an annual pass, the price

of each additional visit to the

visitor ____falls to $0_____

because ____s/he need not pay

for additional visits________.

So the visitor will visit HK

Disneyland until _____his/her

marginal benefit is equal to $0_.

Hence, the number of visit will

__increase from Q1 to Q2__.

$

D

P1

P2=0 Q1 Q2 No. of

visits


d) The total benefit and consumer surplus will be larger under the annual pass /

pay-per-visit scheme.

$

D= MB

P1

0 Q1 No. of

visi

ts

$

D= MB

P1

P2=0 Q1 Q2 No. of

visits

e) The ___higher-demand visitors are more likely to buy the annual pass because

_the total benefit from many visits is more likely larger than the lump sum

fee for the annual pass. A lower-demand visitor may visit HK Disneyland

once or twice a year, so the total benefit is more likely lower than the lump

sum fee for the annual pass. _______________________________________

2a) Producer surplus is ____the extra amount that a producer actually receives

above the minimum amount he must receive to produce a given quantity of

a good.______________

It is the difference between ___total revenue and total variable cost of

production_________________.

_Saudi Arabia_ would enjoy a higher producer surplus because ___the

extraction cost of oil is much lower in Saudi Arabia._______________

b) Some countries import oil from other countries rather than extract oil from their

oil wells because ____the price paid for imported oil is lower than the

extraction cost of oil from their domestic oil wells._________________


CS

TE

Total benefit = consumer surplus + total expenditure= CS + TE

CS

Total benefit = consumer surplus + total expenditure= CS + TE

CS

TE

c) $

S = MC

P2

P1

D1 = MB1 D2 = MB2

0 Q1 Q2 Q

original consumer surplus original producer surplus

new consumer surplus new producer surplus

As both the consumer surplus and producer surplus ___increase___, the total

social surplus would ___increase___.


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Chapter 15 Consumer surplus and producer surplus