Consumer and Producter Surplus Microeconomics

Consumer Surplus  Consumer Surplus is ….  when a consumer pays of price LESS than their maximum willingness to pay.  Willingness to pay is …..  Maximum price a consumer would pay for a particular good or service.

Consumer Surplus  Consumer Surplus is ….  Amount would have paid – amount did pay  The area below the D curve and above P  CS = ½ BH (area of a triangle)  CS = ½ P*Qd

Calculate Consumer Surplus ConsumerWillingness to Pay (WPT) P = $40CS = WTP - P A$100$40$60 B$80$40 C$60$40$20 D$40 $0 E$20$40Will not buy TOTAL CS = $120

Consumer Surplus Calculations Problem : The D curve for a product is P = 40 -2Qd. The current price is $20. Compute Total Consumer Surplus. Draw the D curve with P and Qd. Shade CS. CS = ½((20)(10) = $100

∆P Affects CS Graph the new CS. ConsumerWillingness to Pay (WPT) P = $60CS = WTP - P A$100$60$40 B$80$60$20 C$60 $0 D$40$60Will not buy E$20$60Will not buy TOTAL CS = $60

∆P Affects CS CS  when P . CS  when P .

Producer Surplus  Producer Surplus is ….  when a producer receives a price HIGHER than their cost. Cost is the minimum price the seller must receive to offer the product on the market.

Producer Surplus  Producer Surplus is ….  Price received - cost  The area above the S curve (cost) and below P  CS = ½ BH (area of a triangle)  CS = ½ P*Qs

Producer Surplus Graph Producer Surplus with values. Units SuppliedCostP = $40. Will it be supplied? $30. Will it be supplied? 1$10yes 2$20yes 3$30yes 4$40yesno 5$50no

Producer Surplus Calculations Units SuppliedP = $40CostPS = P - Cost 1$40$10$30 2$40$20 3$40$30$10 4$40 $0 5$40$50Will not be supplied TOTAL PS = $60

Producer Surplus Calculations Problem : The S curve for a product is P = 2Qs. The current price is $60. Compute Total Producer Surplus. Draw the S curve with P and Qs. Shade PS. PS = ½((60)(30) = $900

∆P Affects PS Graph the new CS. Units SuppliedP = $30CostPS = P- Cost 1$30$10$20 2$30$20$10 3$30 $0 4$30$40Will not be supplied 5$30$50Will not be supplied TOTAL CS = $30

∆P Affects CS PS  when P . PS  when P .

CS, PS and TS Measure what?  CS = (value to buyers) – (amount paid by buyers)  Buyers’ benefit from participating in the market  PS = (amount received by sellers) – (cost to sellers)  Sellers’ benefit from participating in the market  Total Surplus = CS + PS  Total gains (loss) from trade in a market

Consumer Surplus, Producer Surplus and Efficiency A trade had been made anytime a consumer makes a purchase from a producer. Widget BuyersWTPWidget SellersCost 1$10A$2 29B3 38C4 47D5 56E6 65F7 74G8

Consumer Surplus, Producer Surplus and Efficiency Gains From Trade Widget Buyers WTPPriceCS 1$10$6$ NT 746 Widget Sellers PriceCostPS A$6$2$4 B633 C642 D651 E660 F67NT G68 What is CS, PS and TS?

CS, PS and Efficiency  An Efficient Market is …..  Equitable gains from trade.  No way to make some better of without making others worse off.

CS, PS and Efficiency  An Efficient Market performs four important functions.  Allocates good consumption to buyers who value it most  Demonstrated by WTP  Allocates sales to sellers who value the right to sell the good most  Demonstrated by cost  Ensures every consumer values the good more than every seller who makes sale  Trade is mutually beneficial  Ensures every consumer who DOES NOT make a purchase values the good less than every seller who DOES NOT make a sale  NO mutually beneficial trades are missed

CS, PS and Efficiency  NOT ALL MARKETS ARE EFFICIENT (EXTERNALITIES) AND/OR EQUITABLE  Widget price of $6 fair for some but not for those whose WTP < $6.  TPS – List two goods/service you think are unfairly priced.  State one thing you would do to correct the price issue?  (minimum wage is a price floor since the wage for unskilled labor is considered unfairly low – abolish minimum wage to increase efficiency?)

CS, PS and Efficiency TAXES Equity and efficiency are at the root of the debate surrounding taxes.  TPS – What is the purpose of taxes?  Redistribute some income from wealthy to the poor

CS, PS and Efficiency TAXES A Progressive tax …  rises MORE in proportion to INCOME  Higher-income pays a higher % than low-income in taxes  A Regressive tax …  Rises LESS in proportion to INCOME  Higher – income pays a smaller % than low-income in taxes  A Proportional tax …  Rises IN Proportion to INCOME  All tax payers pay the same % of their income

The Effects of Taxes on Total Surplus  The Excise Ta x is …  Levied on each unit of a good sold  Ex: Gasoline, tobacco, alcohol, hotel rooms

The Effects of Taxes on Total Surplus EXAMPLE : Smog City is free of any taxes. P = $2/gallon, and 1 million gallons are sold/day. P $5S1 2 D1 1 Q (millions)

The Effects of Taxes on Total Surplus EXAMPLE : Smog City decide to impose a $1 tax on gasoline sellers on every gallon of gas sold. Sellers must receive $3/gallon so they can send $1 to the Smog City government. What is causing the S curve to shift? Which direction will the S curve shift? What amount will the S curve shift by? S2 P $5S D1.8 1 Q (millions)

The Effects of Taxes on Total Surplus Price Elasticities and Tax Incidence  A Tax Incidence is …  the distribution of the tax burden  Depends on the elasticity of the D and S curves.  Buyers pay more when  D curve = Inelastic and S curve = Elastic  Sellers pay more when  D curve = Elastic and S curve = Inelastic

Benefits and Costs of Taxation Revenue from an Excise Tax Tax revenue = (# gallons sold)*(per gallon tax) = 800,000 * $1/gallon = $800,000 P $5 Revenue S2 S D1.8 1 Q (millions)

Benefits and Costs of Taxation Costs of Taxation  The Tax Revenue collected by the government is …  A redistribution of CS and PS to the government.  The True Cost of the Tax is Deadweight loss.  Deadweight Loss is the inefficiency created by the tax.

Benefits and Costs of Taxation Cost of Taxation Deadweight Loss = Before Tax TS – (After Tax TS + Gov. Revenue) $2,500,000 – (1,680, ,000) = $20,000 P $5 Revenue S2 S Deadweight Loss D1.8 1 Q (millions)

Utility Maximization  Utility is a measure of satisfaction the consumer derives from consuming good and services.  Total Utility is the total happiness (utility) received from the consumption of a number of units of a good.  Marginal Utility is the change in happiness (utility) between the initial consumption of a good and each subsequent consumption of the good.  Diminishing Marginal Utility is the principle describes what happens when each successive unit of a good consumer adds less to total utility than the previous utility.

Utility Maximation Number of Slurpees (in a week) Total Utility (TU) Received (happy points) Marginal Utility (MU) from each

Utility Maximization  MU = ∆TU/∆X MU >= 0 the consumer will choose to consume it. When does the consumer no longer consume Slurpees that week? Assumption: consumer can afford to buy 5 Slurpees in a week.

Budgets and Optimal Consumption  Consumers want to maximize utility BUT must do so within a budget.  Consumers need to …  Find the bundle of goods which are affordable  Choose the bundle that provides the highest utility

Bruno’s Budget and Optimal Consumption  Bruno’s income is $50.  Notebooks cost $5.  CDs cost $10. 1.Write the linear equation for Bruno’s data. $50 = $5N + $10CD He CANNOT afford a bundle >$ Create a table of Bruno’s consumption options.

Bruno’s Consumption Options Q of NotebooksQ of CDs