Topic: Surplus and Efficiency

Market transactions take place between consumers and producers

because they can both gain from these transactions.

1 Benefit of consumers

Total benefit (TB) refers to the total gain consumers receive from
consuming certain units of goods.

Marginal benefit (MB) refers to the gain consumers receive from

consuming an additional unit of goods.

Example 1:

Quantity Total benefit Marginal benefit

0 0
1 50
2 90
3 120
4 140
5 150
6 150

Remarks:
⚫ Economists assume that the marginal benefit of consumption
diminishes as the quantity consumed increases

1.1 Maximum willingness to pay

⚫ It refers to the maximum price consumers are willing to pay for a

certain good
⚫ Consumers are unwilling to pay a price higher than the marginal
benefit of a good can bring them

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 ⚫ Maximum willingness to pay = marginal benefit

Therefore, consumers will compare the marginal benefit (MB) and the
price of a good to decide whether to buy an additional unit or not

➢ If MB > Price, then consumer will/will not buy an additional unit of

the good
➢ If MB < Price, then consumer will/will not buy an additional unit of
Unit 11 Surplus and Efficiency 7

the11.1good What is consumer surplus?

➢ Consumer will stop buying the good when ________ = __________
• Celia’s MB from consuming cake:

1.2 Marginal benefit = Demand

© Times Publishing (Hong Kong) Ltd

⚫ Marginal benefit of consuming different quantities can be viewed

as the market prices at which consumers will purchases the
quantity of goods.

⚫ Marginal benefit curve equals demand curve

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 1.3 Consumer Surplus

⚫ It refers to the difference between the total benefit consumers

receive from consuming a good and the amount they actually pay
for the good

If there is a change in price, let say, a reduction in price, then what would
be the effect on consumer surplus?

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Remarks:
⚫ Fall in price → increase in consumer surplus
⚫ Rise in price → Decrease in consumer surplus

Example 2: Calculation of consumer surplus

Quantity Total benefit Marginal benefit

1 20
2 36
3 48
4 56
5 60

Calculate the consumer surplus if the price is $12.

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2 Benefit of producers

Total Variable Cost (TVC) refers to all of the variable costs of

producing certain units of goods

Marginal Cost (MC) refers to the change in total variable cost as a result
of producing an additional unit of output
→ Not affected by fixed cost

Example 3:

Quantity Total Variable Cost Marginal Cost

1 10
2 30
3 60
4 100
5 150

Remarks:
⚫ Economists assume that the marginal cost (MC) of production rises
as total product increases

2.1 Minimum Supply-Price

⚫ It refers to the price that allows producers to provide the good

⚫ Producers are unwilling to produce a good if the price is lower than
the marginal cost
⚫ Minimum supply-price = marginal cost

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Therefore, producers will compare the marginal cost (MC) and the price
of a good to decide whether to produce an additional unit or not

➢ If MC > Price, then producer will/will not produce an additional unit

of the good
➢ If MC < Price, then producer will/will not produce an additional unit
Unit 11 Surplus and Efficiency 18

of the good
11.2
➢ Producer What iswillproducer surplus? the good when ________ =
stop producing
__________
• MC of Dr. E’s Bakery producing cake:

When price = $50:

Price ≧MC of the first 5 pieces
ð Qs = 5 pieces

2.2 Marginal Cost = Supply © Times Publishing (Hong Kong) Ltd

⚫ Marginal Cost under different quantities can be viewed as the

minimum supply-price at which producers will produce that
quantity of goods

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⚫ Marginal Cost curve = Supply Curve

2.3 Producer Surplus

⚫ It refers to the difference between the amount producers

actually receive from the sale of goods (total revenue) and total
variable cost

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If there is a change in price, let say, a rise in price, then what would be
the effect on producer surplus?

Remarks:
⚫ Rise in price → increase in producer surplus
⚫ Fall in price → Decrease in producer surplus

Example 4: Calculation of producer surplus

Quantity Total Variable Cost Marginal Cost

1 2
2 6
3 12
4 20
5 30

Calculate the producer surplus if the price is $6.

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3 Total Social Surplus

⚫ It is the sum of consumer surplus and producer surplus in the

absence of market intervention

It can also be written as:

3.1 Graphic Illustration:

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Example 5: What are the effects of change in demand or supply on total
social surplus?

Case one: Increase in demand

Before After Change

Consumer Surplus

Producer Surplus

Total social
surplus

Case two: Decrease in Supply

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 Before After Change

Consumer Surplus

Producer Surplus

Total social
surplus

4 Efficiency

⚫ Society can get the greatest benefit through resource allocation

Unit 11 Surplus and Efficiency 31

11.4 What is efficiency?

• Condition for efficiency in the cake market:

4.1 Deviation from Efficiency © Times Publishing (Hong Kong) Ltd

⚫ When total social surplus is not maximized, then the market is

inefficient
⚫ It happens when:
→ MB > MC
→ MC < MB
⚫ The efficiency loss caused by the situation in which total social
surplus is not maximized is known as deadweight loss

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 a) MB higher than MC

⚫ Quantity transacted is smaller than equilibrium quantity

Before After Change

Consumer Surplus

Producer Surplus

Total social
surplus

Remarks:

Increasing/Reducing the output can increase total social surplus and

reduce deadweight loss

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 b) MB lower than MC

⚫ Quantity transacted is larger than the equilibrium quantity

Before After Change

Consumer Surplus

Producer Surplus

Total social
surplus

Remarks:

Increasing/Reducing the output can increase total social surplus and

reduce deadweight loss

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 4.2 Market intervention and inefficiency

⚫ When there is market intervention, the market is inefficient

⚫ MB will not be equal to MC

a) Price Ceiling

Without Price With Price Change

Ceiling Ceiling

Consumer Surplus

Producer Surplus

Total social
surplus

Remarks:

➢ Deadweight loss is ________________.

➢ At the new quantity transacted, MB is _________ than MC

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 b) Price floor

Without Price With Price floor Change

floor

Consumer Surplus

Producer Surplus

Total social surplus

Remarks:

➢ Deadweight loss is ________________.

➢ At the new quantity transacted, MB is _________ than MC

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 c) Quota

Without Quota With Quota Change

Consumer Surplus

Producer Surplus

Total social
surplus

Remarks:

➢ Deadweight loss is ________________.

➢ At the new quantity transacted, MB is _________ than MC

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 d) Per-unit tax

Without With Change

per unit tax per unit tax

Consumer
Surplus

Producer
Surplus

Tax Revenue

Total social
surplus

Remarks:

➢ Deadweight loss is ________________.

➢ At the new quantity transacted, MB is _________ than MC

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 e) Per-unit subsidy

Without With Change

per unit subsidy per unit subsidy

Consumer
Surplus

Producer
Surplus

Total subsidy

Total social
surplus

Remarks:

➢ Deadweight loss is ________________.

➢ At the new quantity transacted, MB is _________ than MC

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5 The functions of price

a) Leading to market efficiency

➢ Consumers will continue to consume until _________ = _______

➢ Producers will continue to produce until _________ = ________
➢ Price can make ______________= _____________

b) Rationing goods

➢ Price can direct existing goods to buyers with the highest maximum
willingness to pay
➢ E.g Auction

c) Allocating resources

➢ Relative price of a good can help producers deploy resources from

producing goods with a lower value to producing those with a higher
value

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 Example: 2014 DSE Economics Question 3

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