Producer surplus is the difference between the actual ...

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CONSUMER AND PRODUCER SURPLUS Recall, that consumer surplus is the difference between the value that consumer place on a product and the payment that they actually make to buy that product. Producer surplus is the difference between the actual price that the producer receives for a product and the lowest price that the producer would be willing to accept for the sale of that product.

Allocative efficiency occurs where the sum of consumer and producer surplus is maximized.

The Allocative Efficiency of Perfect Competition Revisited

The allocatively efficient output occurs under perfect competition where the demand

curve intersects the supply curve--that is. the point of equilibrium in a competitive market.

This is shown as the output Q in Figure 12-5. For any level of output below Q, such as

Q, the demand curve lies above the supply curve, showing that consumers value the

product more than it costs to produce it. Thus, society would be better off if

units were produced. surplus earned on the

NunoittiscebethtwateiefnoQutipuant disQo*n.lyThQus,thtehree

is no areas

consumer I and 2 in

more than Q

or producer Figure 12-5

i

represent a loss to the economy.

lower at Q, than at Q.

Total

surplus--consumer

plus

producer

surplus--is

For any level of output above Qb, such as Q2, the demand curve lies below the supply

curve, showing that consumers value the product less than the cost of producing it.

Society would be better off if less than Q' units were produced. If output is Q'. total

surplus is less earn negative

than it is producer

at Q. To see

surplus on the

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aubnoitvs eexQc*eebdescpau.seStihmeiirlamrlya,rgcionnasluvmaelurse

would of the

earn negative consumer product is less than p *?

surplus on the units (You should be able

to convince yourself that for any price, the total surplus negative.) From the figure. we conclude that at any level is less than it is at Qt.

earned on of output

tahbeouvneitQs ?a,btoovtealQsuripslus

The Allocative Inefficiency of Monopoly Revisited

We have just seen in Figure 12-5 that the output in perfectly competitive equilibrium maximizes the sum of consumer and producer surplus. It follows that the lower monopoly output must result in a smaller total of consumer and producer surplus. The monopoly equilibrium is not the outcome of a voluntary agreement between the one producer and the many consumers. Instead, it is imposed by the monopolist by virtue of the power it has over the market. When the monopolist chooses an output below the

competitive level, market price is higher than it would be under perfect competition. As a

result, consumer surplus is diminished, and producer surplus is increased. In this way, the monopolist gains at the expense of consumers. This is not the whole story, however.

When output is below the competitive level, there is always a net loss of total surplus: More surplus is lost -by consumers than is gained by the monopolist. Some

C

surplus is lost because output between the monopolistic and the competitive levels is not

produced. This loss of surplus is called the deadweight loss ofmonopoly. It is illustrated in

Figure 12-6.

It follows that there is a conflict between the private interest of the monopolist and the public interest of all the nation's consumers. This creates grounds for government intervention to prevent the formation of monopolies or at least to control their behaviour

4)

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FIGURE 12-4 consumer and Producer Surplus In a Competitive Market

S Marginal cost

at p0

Marginal

value

(2?

Quantity

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FIGURE 12-5 The Allocative Efficiency of Perfect competition

U U

Competitive market price

p.

Qi (2' Q1

Quantity

Competitive equilibrium is .illocativcly efficient because

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%Lirplus is the red are:) below the price line.

Fur any ``input that is tess than Q, the sum of the two

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than total

FIGURE 12-6 The Deadweight Loss of Monopoly

zC Pm &

PC

C

Marginal cost S for competitive

market)

D = Marginal value

L

0

Output

Marginal revenue (for monopolist)

Monopoly restricts output and reduces total surplus,

thereby imposing a deadweight loss on society. If this

market were perfectly competitive, output would be

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of areas 1, 2, and 3. Producer surplus would be the

sum of areas 4 and 5.

When the industry is monopolized, and the

monopolist has the same marginal costs as the compet

itive industry, output is restricted to Qm and price rises

to p,,,. Consumer surplus is reduced to the blue area.

Producer surplus rises by area 2 but falls by area 5.

(Since know

Pm that

must maximize the area 2 is larger than

producer's profit, we area 5.) Total producer

surplus for the monopolist is therefore the red area.

The deadweight loss of monopoly is the purple

area. This area represents the additional surplus that

would be earn?d if the market were competitive. Since

the monopolist restricts output to Q,,,, the units

between Q,,,

they generate

and Q

neither

are not produced and consumer nor producer

therefore surplus.

CONSUMER AND PRODUCER SURPLUS PROBLEMS

1. Consider the market for cheese-stuffed jalapeno peppers.

Quantity of Peppers 1st Pepper 2nd Pepper

3rd Pepper 4th Pepper

Casey's Willingness To Pay $0.90 $0.70 $0.50 $0.30

Josie's Willingness To Pay $0.80 $0.60 $0.40 $0.30

There are two consumers, Casey and Jose and their willingness to pay for each pepper is given in the accompanying table. Use the table to

a) construct the demand schedule for peppers. b) Calculate the total consumer surplus when the price of a pepper is $0.40.

2. Consider the market for cheese-stuffed jalapeno peppers.

Quantity of Peppers 1st Pepper

2 Pepper 3rd Pepper 41h Pepper

Can's Cost $0.10 $0.10 $0.40 $0.60

Jamie's Cost $0.30 $0.50 $0.70 $0.90

There are two producers Cara and Jamie and their costs of producing each pepper are given in the accompanying table. Use the table to

a) construct the supply schedule for peppers. b) Calculate the total producer surplus when the price of a pepper is $0.70.

3. Determine the amount of consumer surplus generated in each of the following situations:

a) Paul goes to the clothing store to buy a new T-shirt, for which he is willing to pay up 10 $10. He picks out one he likes with a price tag of exactly $10. At the cash register he is told that his T-shirt is on sale for half the posted price.

b) Robin goes to the CD store in town hoping to lind a used copy of the Eagles Greatest Hits for up to $10. The store has one copy selling for $10.

c) After soccer practice, Phil is willing to pay $2 for a bottle of mineral water. The 7-Eleven sells mineral water for $2.25 per bottle.

t

4.

Determine the amount of producer surplus generated in each of the following

situations:

a) Bob lists his old Lionel electric trains on eBay. He sets a minimum acceptable price, known as his reserve price of $75. After 5 days bidding, the final high bid is exactly $75.

b) Jenny advertises her car for sale in the used car section of the student newspaper for $2,000, but she is willing to sell the car for any price higher than $1,500. The best offer she gets is $1,200.

c) Sanjay like his job so much that he would be willing to do it for free. However, his annual salary is $80,000.

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