Why use the concept of producer, consumer surplus, and total surplus to explain the outcomes of markets for individuals, firms, and society?
Students often see this topic on surplus as technical, but it’s really fundamental to understanding economics if you realize what it’s about. Economists believe that voluntary transactions (purchases and sales) are mutually beneficial. It is not the case that one side gains and the other side loses. Rather, transactions are positive sum games in which both parties are better off as a result. In principle, we can measure the gains to both parties. This measurement is the rationale for two important concepts: consumer surplus and producer surplus, which together make up economic (or social) surplus—the gain to society from the transaction. This is the subject of this module.
Surplus, in the context of this module, just means how good a deal a consumer got on a purchase, or how good a deal a producer got on a sale. That’s it in a nutshell.
For consumers, this is often highlighted by a sale when deals become bigger. Sales promotions bring in customers who wouldn’t pay the normal price. But they also allow customers who would have purchased anyway to get an even better deal. Watch this BBC video about Cyber Monday to find out more about how consumers react to large sales.
How big a deal do consumers get together from Cyber Monday? We can answer this question by computing the consumer surplus.
What about businesses? Why do they run sales like Cyber Monday, and how much do they gain from them? The answer can be found by computing the producer surplus.
Let’s see how it’s done.
- Define and calculate consumer surplus
- Define and calculate producer surplus
- Define and calculate total surplus
- Use the concepts of consumer, producer and total surplus to explain why markets typically lead to efficient outcomes