Finding Consumer Surplus and Producer Surplus Graphically

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Consumer and Producer Surplus

In the context of welfare economics, consumer surplus and producer surplus measure the amount of value that a market creates for consumers and producers, respectively.  Consumer surplus is defined as the difference between consumers' willingness to pay for an item (i.e. their valuation, or the maximum they are willing to pay) and the actual price that they pay, while producer surplus is defined as the difference between producers' willingness to sell (i.e. their marginal cost, or the minimum they would sell an item for) and the actual price that they receive.

Depending on context, consumer surplus and producer surplus can be calculated for an individual consumer, producer, or unit of production/consumption, or it can be calculated for all consumers or producers in a market.  In this article, let's take a look at how consumer surplus and producer surplus are calculated for an entire market of consumers and producers based on a demand curve and a supply curve.

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Finding Consumer Surplus Graphically

In order to locate consumer surplus on a supply and demand diagram, look for the area:

  • Below the demand curve (when externalities are present, below the marginal private benefit curve)
  • Above the price that the consumer pays (often just the "price," and more on this later)
  • To the left of the quantity that consumers buy (often just the equilibrium quantity, and more on this later)

These rules are illustrated for a very basic demand curve/price scenario in the diagram above.  (Consumer surplus is of course labeled as CS.) 

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Finding Producer Surplus Graphically

 The rules for finding producer surplus are not exactly the same but do follow a similar pattern.  In order to locate producer surplus on a supply and demand diagram, look for the area:

  • Above the supply curve (when externalities are present, above the marginal private cost curve)
  • Below the price that the producer receives (often just the "price," and more on this later)
  • To the left of the quantity that producers produce and sell (often just the equilibrium quantity, and more on this later)

These rules are illustrated for a very basic supply curve/price scenario in the diagram above.  (Producer surplus is of course labeled as PS.) 

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Consumer Surplus, Producer Surplus, and Market Equilibrium

In most cases, we won't be looking at consumer surplus and producer surplus in relation to an arbitrary price.  Instead, we identify a market outcome (usually an equilibrium price and quantity) and then use that to identify consumer surplus and producer surplus.

In the case of a competitive free market, the market equilibrium is located at the intersection of the supply curve and the demand curve, as shown in the diagram above.  (Equilibrium price is labeled P* and equilibrium quantity is labeled Q*.)  As a result, applying the rules for finding consumer surplus and producer surplus leads to the regions labeled as such.

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The Importance of the Quantity Boundary

Because consumer surplus and producer surplus are represented by triangles in both the hypothetical price case and in the free-market equilibrium case, it's tempting to conclude that this will always be the case and, as a result, that the "to the left of quantity" rules are redundant.  But this is not the case- consider, for example, consumer and producer surplus under a (binding) price ceiling in a competitive market, as shown above.  The number of actual transactions in the market is determined by the minimum of supply and demand (since it takes both a producer and consumer to make a transaction happen), and surplus can only be generated on transactions that actually happen.  As a result, the "quantity transacted" line becomes a relevant boundary for consumer surplus.

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The Importance of a Precise Definition of Price

It also may seem a bit strange to refer specifically to "the price that the consumer pays" and "the price that the producer receives," since these are the same price in many cases.  Consider, however, the case of a tax- when a per-unit tax is present in a market, the price that the consumer pays (which is inclusive of the tax) is higher than the price that the producer gets to keep (which is net of the tax).  (In fact, the two prices differ by exactly the amount of the tax!)  In such cases, therefore, it is important to be clear regarding which price is relevant for calculating consumer and producer surplus.  The same is true when considering a subsidy as well as a variety of other policies.

To further illustrate this point, the consumer surplus and producer surplus that exists under a per-unit tax is shown in the diagram above.  (In this diagram, the price that the consumer pays is labeled as PC, the price that the producer receives is labeled as PP, and the equilibrium quantity under the tax is labeled as Q*T.)

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Consumer and Producer Surplus Can Overlap

Since consumer surplus represents value to consumers whereas producer surplus represents value to producers, it seems intuitive that the same amount of value can't be counted as both consumer surplus and producer surplus.  This is generally true, but there are a few instances that break this pattern.  One such exception is that of a subsidy, which is shown in the diagram above. (In this diagram, the price that the consumer pays net of the subsidy is labeled as PC, the price that the producer receives inclusive of the subsidy is labeled as PP, and the equilibrium quantity under the tax is labeled as Q*S.)

Applying the rules for identifying consumer and producer surplus precisely, we can see that there is a region that is counted as both consumer surplus and producer surplus.  This may seem strange, but it's not incorrect- it's simply the case that this region of value counts once because a consumer values an item more than it cost to produce ("real value," if you will) and once because the government transferred value to consumers and producers by paying out the subsidy.

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When the Rules Might Not Apply

The rules given for identifying consumer surplus and producer surplus can be applied in virtually any supply and demand scenario, and it's difficult to find exceptions where these basic rules need to be modified.  (Students, this means that you should feel comfortable taking the rules literally and precisely!)  Every once in a great while, however, a supply and demand diagram might pop up where the rules don't make sense in the context of the diagram- some quota diagrams for example.  In these cases, it is helpful to refer back to the conceptual definitions of consumer and producer surplus:

  • Consumer surplus represents the spread between consumers' willingness to pay and their actual price for units that consumers actually buy.
  • Producer surplus represents the spread between producers' willingness to sell and their actual price for units that producers actually sell.