Video Transcript: Producer and Consumer Surplus
Hello, welcome. In this video, we're going to discuss producer and consumer surplus. So let's define consumer surplus. Consumer surplus is an economic measure of consumer benefit, which is calculated by analyzing the difference between what consumers are willing to pay for a good or service relative to its
market price, so so a consumer could be willing to pay more than the market price, or or their appetite could be a little bit less than the price, right? So this is a marginal benefit measurement. Okay, so what are we going to receive above the as a as a personal benefit to me? My value for something could be higher than the market price, and therefore, whatever I value that good or service at that price, and and if I have a greater value, if I think something is worth $60 when it's priced in the market at $30 My marginal benefit for that product is the actual $30 because I personally value that product more than the market values the product. So therefore, I receive a marginal benefit. A consumer surplus occurs when the consumer is willing to pay more for a given product than the current market price. Consumer surplus is based on the economic theory of marginal utility. Remember, utility is the benefit we receive from something. Okay, so if I eat ice cream, you know, and and and I really enjoy ice cream. But if I go to buy a second cone of ice cream, my benefit or my utility is probably going to be less for that second cone of ice cream than it was for the first cone of ice cream because my I've been satisfied with the first cone, so I won't value the second cone as much because now my taste for ice cream may have diminished. So there's a marginal benefit greater for the first cup of ice cream than let's say the second. So the utility of a good or service provides that that a good or service provides that varies from individual individual to individual based on his or her own personal preference, right? So, economic law holds that the more a consumer has a good, has of a good, the less he is willing to spend for more due to the diminishing marginal utility he receives. Just like we talked about the ice cream, right? So, if you get the second cup of ice cream, your marginal utility will be diminished because my appetite for ice cream had already been pretty much satisfied satisfied by the first cup. So I go to the second cup, and you know my utility for that second cup probably isn't as great. So let's graph the idea of of a consumer surplus, right? So we're going to talk about cars, right? In this example, so for a new car, we're going to discuss several different consumers. Okay, so let's draw our supply and demand curve. Okay. For this example, we'll only be dealing with demand curve because it's for consumers only. So let's draw our demand curve here. Okay. So let's say the price in the market for this new car is $30,000 right? So let's go 60, 50, 40, 30, and let's look at the quantity of new cars sold per day. Okay. Now, this first consumer. This will represent the consumer. Okay, and then this will represent the price, so let's put price on this axis, and let's put quantity down here per day. So now, if we look at the first consumer, so this is our price, right? This is the market price, the 30, and this is all in 1000s, right? 60,000 50,000, 40, 30, etc.
right? So let's say the market price for this car is $30,000 right? So here is our. Market price. Okay, now this is this curve is not necessarily a demand curve. It's more of a marginal benefit curve, right? This is measuring the benefit received from the consumer or by the consumer for the new car, right? So we want to see do what do the consumers receive in surplus utility value? Right. What are they receiving as value that they feel that they are getting a good deal, and whatever they see as the price, whatever they feel like they would pay for that vehicle for the new car above the market price is the marginal benefit they'll receive from buying that car, right? So let's take a look here. So let's draw our line here. Okay. So now our first consumer comes in and they are willing to pay $60,000 for this $30,000 car because they really like this car. It's it's it's in their eyes nothing better on the market for $60,000 than that car, and they really want to buy that car, and they are willing to pay 60,000 even though the market price is 30. But in the consumer's eyes, they will value that vehicle or the new car at $60,000 in their mind, saying, "I really like this car, and if this car was $60,000 I would still buy it. So their marginal benefit of this new car, this first consumer, is $30,000 above the market price. So let's put the marginal benefit for consumer one at 30,000 right? So they received a marginal benefit of $30,000 above the market price because they really, really like this car. They they think they received a benefit of this car that was worth more than twice the value in the market. Now the second consumer comes in, and let's say they already have a new car and their wife wants a car, but they already bought a brand new car, so maybe their taste for another new car has diminished a little bit, right? So they already have a car, so they're coming in to buy the second car. Now let's say that they're willing to pay for this exact same car $50,000 because they already bought a car. They're satisfied. They like that car. They really like this car, but because they just bought a brand new car, maybe their tastes aren't as high as the first consumer. So they're only willing to pay $50,000 because they just bought a car and now their taste for a car has probably went down. So they will spend $50,000 even though the market price is 30, right? Even though the market price is 30, they would be willing to pay 50. So in this instance, they will be receiving a $20,000 marginal benefit. And remember, marginal benefit is just talking about the consumer and their appetite for a product, right? This has nothing to do with market pricing. This is just a consumer and their feelings and their marginal benefit or utility that they will receive from buying a new car, right? So now let's say the third person walks in, right, and they really they've got two cars. They want to buy another car for their for their you know 18 year old graduate, right? So they want to purchase a new car for them before they go to college. But because they've already purchased two new cars and they really do like this car, it's a top-of-the-line car. They they would be willing to pay $40,000 even though it's only 30,000 in the market. So. So now we see that the marginal benefit for consumer two is 20,000 and the marginal benefit for consumer three
is 10,000 So remember, it's a marginal benefit. Anything that they will receive in value above the market price is going to be known as the marginal benefit or utility. So now we've got the next consumer come in. They have already enough cars, right? They're just looking to buy an extra car. So, for them, they are willing. They're willing to pay the market price. They only want to pay the market price. If it was a little below $30,000 you know that would be a good deal for them. A little more than $30,000 would probably break the deal. They don't need the car. They're just buying it for an extra vehicle and something to have is some security. Right, so they're not willing to pay more than the market price because they really don't need the car. So their benefit of buying this extra unit or buying this additional car will not be as much as say the individuals or the consumers that only have one, two, or three cars. Right, they are looking for the fourth car, but they really don't want to pay above the 30,000 because their benefit above that 30,000 is very very minimal or non-existent, right? So here they are on the fence, but they would possibly buy at $30,000 now. So this is our break-even essentially, right? This is the market price. Okay, so here is the market price, right? So we'll we'll identify that anything above this market price is the consumer surplus. This will be known as the consumer surplus, right? So now we can quantify this. We can we can measure the consumer surplus for this new car in the market, right? So we can add up the marginal benefit from each consumer, right? So the marginal benefit from each consumer total consumer surplus. Okay, so $30,000 plus $20,000 plus $10,000 equals $60,000 So in this example, the marginal benefit or the total consumer surplus for this example is $60,000 Next, let's discuss producer surplus. Producer surplus is an economic measure of the difference between the amount a producer of a good receives, and the minimum amount the producer is willing to accept for the good. The difference, or surplus amount, is the benefit the producer receives for selling the good in the market. Producer surplus is generated by market prices in excess of the lowest price producers would otherwise be willing to accept for their good. Producer surplus is shown graphically, as we will cover, and so you'll see when we draw this out that the producer surplus will be the area above the producer supply curve that it receives at the point at the price point, right, forming a triangular area on the graph. The size of the producer surplus and its triangular depiction on the graph increases as the market price for the good increases and decreases as the market price for the good decreases. Producer surplus combined with consumer surplus equals overall economic surplus or the benefit provided by producers and consumers interacting in a free market as opposed to one with price controls or quotas. Right? If a producer had the ability to price discriminate perfectly, or rather charge every consumer the maximum price the consumer is willing to pay, then the producer would capture the entire economic surplus. In other words, producer surplus would equal overall economic surplus. So let's take a look and graphically illustrate producer surplus. Okay. Now we
will have a supply and a demand curve. So let's shoot demand here. Okay, and let's go with supply here. Okay, so this is supply. Okay, this is demand. Remember, demand is downward sloping, supply is upward sloping. So now let's make sure we have our quantity and our price points right. So our quantity will be in 1000s of pounds. Okay, and this is our price. So we'll say for 1000 pounds, 2000, 3000 pounds, 4000, 5000 pounds, and let's say price per pound 2, 3, 4, 5, Okay, so we want to illustrate here. Let's say that we are producing berries. Right? Again, we'll go back to the to the berry producers. Okay, so at this first, so let's say the the price per pound, let's say the market price per pound is $4 dollars, right? But at one, at one. So let's say we want to produce 1000 pounds of berries, right? So at this 1000 quantity point, right? Our opportunity cost is going to have to be exactly $1 per pound for 1000 pounds, right? So if we are making, so if we can use our land, if we can utilize our land to grow these berries, and we can make $1 per 1000 pound right here, right, and we we can't receive any more money for using this land, right? We can't. So let's say we want to we want to make sure that there's nothing better. There's not a better use of our land that can yield us more profit or more revenue, right, than these berries. So, if we can, let's say we can only grow for whatever reason. The demand indicates we can only grow 1000 pounds of berries, and we can sell it for $1 per pound. Well, for that $1,000 for that usage of our land, there cannot be a better use or a more profitable use of the land, right? Than growing these berries. Otherwise, we would graze cattle, grow apples, etc. Right? We would use it for something else other than growing berries. So let's just assume that there is no better opportunity cost, right, for our berries. Right. So let's look here. Okay. So this will be incremental, right? This will our supply, what we produce and what we supply into the market will be incremental. It'll move incremental along this line, right? So, so let's just say for the first 1000 pounds, right? This is our first area. Now, this will move as we move forward. Right. And let's say now we're able to produce 2,000 pounds, right? Let's say we're able to produce 2,000 pounds, right? So now, as we are moving along this scale, right? We are wanting to get to obviously equilibrium here, right? So right now we are underproducing, but the cost in the market, the market per pound is $1 But we are actually receiving $4 right? Even though the graph says $1 here, the market is pricing it at $4 but we would take $1 per pound for the 1000 pounds produced. We would sell $1 per pound for the 1000 pounds. Likewise, for the 2000 pounds, we would want it. We would charge 2000 pounds. But notice the equilibrium price in the market is at $4 right? So we want to make so even though we we would sell for $1 right? We would sell for $1 The market is charging $4 so obviously we're not going to sell for $1 We're going to sell for $4 right? So this is going to create a producer surplus, right? So now we move along, right, to our next price point. Now let's say the market says we can develop, or we can grow, or we can produce 3000 pounds. The demand is calling for 3000 pounds. Okay,
we're still not at the equilibrium price, right? So, finally, we are producing enough. We are maximizing our our land, and we are now becoming more efficient and effective, and we're able to now. Produce at the equilibrium price enough product in the market to have our operation come into equilibrium, right? But because we can't go greater than four, right? Because we can't go greater than four, we can't charge more. We could charge more than $4 but it's going to impact our sales, right? So we want to be in equilibrium with the market, right? So we want to produce as much as we can that the market will allow at the current market price, right? So we're producing here, okay? So we are making, we are now producing about 4000 pounds, right? Okay. Now this area above our supply line will indicate our surplus, and why is it a surplus? Why is this area a surplus? Because at the 1000 pounds, we would charge $1 but because the market price is $4 at the $1 at the 1000 pound quantity, we would receive a three as a producer, we would receive a $3 marginal benefit, right? We're going to take because we would charge $1 right? But the market is charging $4 We would say that our producer surplus at the 1000 point, right? So we would say four minus one, okay? Because we're going to say the market is allowing the price or is calling for the price. There has an equilibrium price of $4 per pound, but as a producer, we would charge $1 per pound. So we are making up a marginal benefit. We are receiving a marginal benefit here of $3 Now we're gonna we have to look at it geometrically here, right? So so here we would have to take. Let's say this is our rectangle here, right? So simple geometry, right? So we have our $3 but because our surplus line will cut our rectangle in half, we have to divide by or multiply by a half, right? We're just solving for the equation of a triangle here, right? We're solving for the equation of a triangle right here, right? We're solving for this producer surplus, right? Okay, times the 4000 quantity, right? The 4000 quantity. Our marginal benefit is $3 from the initial 1000 We can produce at the equilibrium price 4000 units. So our marginal producer surplus is $6,000 as we so our so our benefit of this entire curve at 4000 pounds produced as we slide along this scale is $6,000 of producer surplus. So we are capturing an extra $6,000 right? As we produce up this scale and come into equilibrium at 1000, 2000, 3000, 4000 we are receiving a surplus in benefit here as our production is ranked lower, right? But we obviously want to maximize our revenue and therefore our profit potential, right? And we want to produce as much and sell as much as we can. So it's not beneficial for us to only produce 1000 because we can make more money, right? And we're not in equilibrium. Though at this 1000 price, at this 1000 quantity, we would take $1 but it's selling for $4 So we are capturing the surplus here. This is our marginal benefit for producing berries in this market. So our entire marginal benefit for the producer surplus is $6,000