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GT Concept Note
ECO2013 - Spring 2010

Consumer Surplus

Several times throughout the course, weve used demand curves to represent an
individuals (or a markets) demand for a specific good. The Law of Demand says that as the
price of a good increases, the consumer purchases less of that good. But how much worse
off is the consumer after the price increase? Equivalently, how much better off would the
consumer be if he could purchase the good at a lower price?
To quantify this value, we need to first introduce some terminology. Lets begin with
a simple example, where a consumer buys a single good. The consumer has a certain
reservation price relating to this good. If the price of the good is above this reservation
price, the consumer is not willing to buy the good; if it is at or below this reservation price,
the consumer is willing to buy the good. We call this reservation price the consumers
willingness to pay for the good, or the amount that he values the good.
Often, consumers are able to purchase goods at a price that is below their maximum
willingness to pay. For example, imagine a consumer values a certain car at a price of
$20,000, but the car is currently listed at a price of $17,000. Because the consumer is able
to pay $17,000 for a car that he values at $20,000, he would be $3,000 better off. This dollar
measure of how much better off a consumer is because he gets to purchase a good at the
prevailing market price is called his consumer surplus.
The calculation of consumer surplus is simple when a consumer has a choice
between buying either one unit or zero units. When a consumer has the option of buying
more than one unit, the story becomes a bit more complex. This is because he may value
additional units of the good differently than the first. For a quick example of how this
works, suppose that you value one Krispy Kreme donut at $3.00, and pay the $2.00 market
price for it. After you eat that donut, you may want another one, but not quite as much as
you wanted the first, since youve already had one. So, lets say you value the second donut
at $2.00. You buy the second donut at the market price of $2.00. Now, the third donut has a
value to you of $1.50, so you dont buy a third, because the market price is above your
willingness to pay. In all, youve consumed two donuts, paid $4.00 for them, but your
willingness to pay for the two donuts was $3.00 + $2.00 = $5.00. Your consumer surplus in
this example is $1.00.
In the previous example, we had to know the consumers willingness to pay for each
additional unit consumed. We call this value the marginal willingness to pay. Since
demand curves tell us how many units of a good a consumer is willing to buy at any given
price, a consumers demand curve is nothing more than a locus of points that tells us his
marginal willingness to pay for different units of the good. The consumer will continue to
buy additional units of a good as long as his marginal willingness to pay for the next unit
exceeds the market price.

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GT Concept Note
ECO2013 - Spring 2010

Here, we see a consumers demand curve (marginal
willingness to pay) for a good. The points show his quantity
demanded for certain prices. Suppose that price is actually
$4. For the first unit, we can see that his maximum
willingness to pay is $7; as he only pays $4, the going market
rate, he has a surplus of $3 on that unit, shown by the light
rectangle in the graph. Similarly, when paying $4 per unit, he
has a surplus of 6-4 = $2 on the second unit, and 5-4 = $1 on
the third unit. The following table summarizes this
information.

Q
1
2
3
4

Marginal
Willingness to Pay
7
6
5
4

Total
Surplus
3
3+2=5
3+2+1=6
3+2+1+0=6

Total Willingness to
Pay
7
7+6=13
7+6+5=18
7+6+5+4=22

So, the consumers total willingness to pay for all four units is $22. By paying $4 per unit, he
pays a total $16, and thus has a consumer surplus of $6.
If we have a linear demand curve, we dont have to add up the surplus for each unit
to find total consumer surplus. Instead, we can just find the area of the triangle under the
demand curve and above price this will give us total consumer surplus.

Example: Consumer Surplus

Suppose market demand is given by the equation P = 10 .004Q and the current price
is $2. Find the market consumer surplus.
Solution: The easiest way to find market CS is to graph the curve. At a price of $2, the
market quantity sold is 2,000 units:

Consumer surplus is just the area of the indicated triangle. The base of the triangle is
2,000 and the height is 10 2 = 6 , so consumer surplus is

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GT Concept Note
ECO2013 - Spring 2010

CS =

2, 000(8)
= 8, 000
2

Producer Surplus
We now discuss how much better off firms are as a result of the ability to sell at the
market price. On the consumer side, we defined willingness to pay as the consumers
reservation price. This reservation price was based on the consumers preferences how
much he valued the good. A firm has a reservation price at which they are willing to sell
their goods. This price is based on the cost to the firm of producing the units. The firms
cost of producing the next unit is called the marginal cost. Since supply curves tell us how
many units of a good a firm is willing to sell at any given price, a firms supply curve is
nothing more than a locus of points that tells us its marginal cost for different units of the
good. The firm will continue to sell additional units of a good as long as its marginal cost to
produce the next unit is below the market price; that is, as long as selling the next unit is
profitable for the firm.
Producer surplus is a dollar value that measures how much better off a firm is
because it gets to sell its product at the prevailing market price. It is the analogue of
consumer surplus, but for firms. If we have a linear supply curve, finding producer surplus
is as easy as finding consumer surplus: just find the area of the triangle above the supply
curve, and below price.

Example: Producer Surplus

Suppose market supply is given by the equation P = 1 + .002Q and the current price is
$2. Find the market producer surplus.
Solution: The easiest way to find market PS is to graph the curve. At a price of $2, the
market quantity sold is 500 units:

Producer surplus is just the area of the indicated triangle. The base of the triangle is 500
and the height is 2 1 = 1 , so producer surplus is

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GT Concept Note
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PS =

500(1)
= 250
2

Deadweight Loss
We have seen that both producers and consumers benefit from being able to buy
and sell at prevailing market prices. Societys total surplus is the sum of the consumer
surplus and the producer surplus in a market.
When markets are not in equilibrium, total surplus is not being maximized. The
difference between the maximum total surplus and actual total surplus is called
deadweight loss. It is value that producers or consumers arent receiving because of some
outside interference, such as a tax or subsidy. It is easiest to explain through an example.
Suppose demand for corn is P D = 20 .001Q D and supply of corn is
P S = 10 + .004Q S . (Notice that our prices have superscripts on them now, to distinguish the
price that consumers pay for a product from the price that firms receive. We will do this
whenever dealing with a tax or a subsidy, as these two prices usually differ). Setting
P D = P S and Q D = Q S to find equilibrium quantity, we get

20 .001Q = 10 + .004Q
10 = .005Q

Q = 2000
Price is

P D = 20 .001(2000)
P D = 18

So equilibrium price is $18 and the market quantity transacted is 2,000 units. Now,
suppose that the government imposes a tax on the market for corn of $1 per unit. This
means that every time a consumer buys a unit of corn, $1 of the price he pays goes to the
government; in other words, the difference between the price the consumer pays (PD) and
the price the producer receives (PS) is $1:

P D = P S + 1

It is important to understand that this doesnt mean that the firm is paying the entire $1
tax. As we discussed earlier, the supply curve is determined by the firms marginal cost of
producing an additional unit. Since they now have to send $1 for each unit they sell to the
government, it is as if their MC has increased, shifting the supply curve up. This will result
in a higher price for the consumer, which means that ultimately some of the tax burden
falls on him as well. How much is dependent on the elasticities of supply and demand.
To find out the new quantity transacted after the tax, we simply substitute the
equation above into either demand or supply, and solve the new system of equations. Note

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GT Concept Note
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that we still have one quantity ( Q S = Q D = Q ), because the higher price to the consumer
means the short side of the market is the demand curve:

P D = 20 .001Q

(demand curve)

P S + 1 = 20 .001Q

(substituting P D = P S + 1)

P S = 19 .001Q

(demand curve after substitution)

P S = 10 + .004Q

(supply curve)

0 = 9 .005Q
Q = 1800

(subtracting the two equations)

So 1,800 units are transacted after the tax. This seems reasonable, as the tax effectively
makes the price higher, which means consumers will demand less than the original 2,000
units. To find the price the consumer pays and the price the firm receives after paying the
tax, use the original supply and demand equations:

P D = 20 .001(1800)

P D = $18.20
P S = 10 + .004(1800)

P S = $17.20
We see that indeed the difference in prices is $1. What is the impact of the tax on total
surplus? Lets look at some graphs to summarize what we know so far.

The left graph shows the equilibrium price and quantity, and the total surplus (consumer +
producer) as a result. The right graph shows the effect of the tax. The upward shift in
supply to S + tax represents the effect to the firms MC as a consequence of the tax. The
price that consumers pay (18.20) and that firms receive (17.20) is different by $1, the value
of the tax.

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GT Concept Note
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How do we analyze the change in total
surplus (and thus the deadweight loss) that occurs
because of the tax? We can see from the above
graphs that both consumer surplus and producer
surplus is less than it was. However, because the
tax revenue of $1 per unit is going to the
government, we must include that in how well off
society is on the whole (total surplus). What is the
total tax revenue? For each of the 1800 units sold,
$1 goes to the government; in other words, a total
of $1 1800 = $1, 800 goes to the government as
tax revenue. This is indicated by the red square
labeled Tax Rev in the graph to the right.

What of the last triangle of surplus that was lost because of the tax? This is the
deadweight loss, shown by the black shaded triangle in the graph labeled DWL. The
deadweight loss results from value-added units that arent being consumed. In our
example, we can see that there are 200 more units in this market that arent being
consumed whose benefit to consumers is greater than their cost of production (based on
the demand curve for those units being above the supply curve). In the absence of the tax,
these units would be consumed and would add value to society; because of the tax, the
value simply disappears.
To calculate the deadweight loss, just find the area of the black triangle. It has a base
of 2000 1800 = 200 and a height of 18.20 17.20 = 1 , so the total DWL is
1
(200)(1) = $100
2
In short, if we calculated the consumer and producer surplus before the tax, it would be
$100 more than the consumer surplus, producer surplus, and tax revenue after the tax.
DWL =

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