Prof. K. V.

Bhanu Murthy
Consumer & Producer Surplus
Consumer surplus is the difference between what the consumer
has to pay for a good and the amount he/she is willing to pay.
It is the area under the demand curve & above the price.

P
S

P*

D
Q* Q
 Producer surplus is the difference between what the
producer receives for the good and the amount he/she must
receive to be willing to provide the good.
It is the area above the supply curve & below the price.

P
S

P*

D
Q* Q
 Social Welfare

Social welfare = consumer surplus + producer surplus.

In cases where there is tax revenue involved, that is
added as well in the computation of social welfare.
 Let’s look at the sizes of the consumer &
producer surpluses at various output levels.
At quantity Q1 & price P1, consumer surplus is the
purple area & producer surplus is the green area.

P
S
P1

Q1 Q
As we increase the quantity & reduce the price,
the total area of the consumer & producer
surpluses increases,
P
S
P2

Q2 Q
 and increases,

P
S

P3

D
Q3 Q
until we reach the perfectly competitive
equilibrium.

P
S

P*

D
Q* Q
We can not continue this process beyond that equilibrium
however.
Output levels greater than the equilibrium will only be
purchased at prices below the equilibrium price, but they
will only be produced at prices above the equilibrium price.
So there is no price at which those output levels will be
produced & sold.
P S
PS
PD

D
Q4 Q
 We have found that social welfare,
which equals
total consumer & producer surplus,
is maximized at the
perfectly competitive equilibrium.
 How do we compare the social welfare
of two different situations?
1. Calculate the welfare from situation 1 by summing its
consumer surplus and producer surplus:
W1 = CS1 + PS1.
2. Calculate the welfare from situation 2 by summing its
consumer surplus and producer surplus:
W2 = CS2 + PS2.
3. Calculate the difference,
W2 – W1 = (CS2 + PS2) – (CS1 + PS1).
This tells us the gain or loss of welfare of one situation
relative to the other.
When a policy results in a loss of welfare to society,
that loss is often referred to as the deadweight loss.
Notice that we just calculated the social
welfare gain or loss as the difference in
combined consumer and producer surplus,
W2 – W1 = (CS2 + PS2) – (CS1 + PS1).
An alternative equivalent way is the following.

1. Calculate the change in consumer surplus:

ΔCS = CS2 – CS1 .
2. Calculate the change in producer surplus:
ΔPS = PS2 – PS1 .
3. Add to get the total gain or loss in social welfare:
ΔCS + ΔPS = (CS2 – CS1) + (PS2 – PS1)
Let’s explore the welfare effects of
some government policies.
 Price Ceilings
Without the ceiling our consumer & producer
surpluses are as shown by the purple & green areas.
P
S

P*

D
Q* Q
With price ceiling, Pc , the consumer & producer
surpluses are as shown.

P
S

Pc

Qc Q
Consumers have lost area V but gained area U.

P
S

V
U
Pc

Qc Q
The consumers who gain are those who get the product
at a lower price.
The consumers who lose are those who are no longer
able to buy the product because there is less supplied.
P
S

V
U
Pc

Qc Q
In the graph shown, area U is larger than area V,
so consumers as a whole gain. However, if area
U is smaller than area V, consumers lose.
P
S

V
Pc U

Qc Q
Producers have lost areas U and W.

P
S

U W
Pc

Qc Q
So area U just moved from producers to consumers,
but areas V and W were lost to everyone.

P
S

V
U W
Pc

Qc Q
Area V+W is the difference in the total consumer and
producer surplus with and without the policy
(CS2 + PS2) – (CS1 + PS1).
P
S

V It is the deadweight
W loss to society that
Pc results from the policy.

Qc Q