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Part IV: Consumer Surplus Producer Surplus

ECONOMICS. What does it mean to me?. Part IV: Consumer Surplus Producer Surplus. VOCABULARY. Willingness to Pay : the maximum price at which he/she would pay for a good.

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Part IV: Consumer Surplus Producer Surplus

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  1. ECONOMICS What does it mean to me? • Part IV: • Consumer Surplus • Producer Surplus

  2. VOCABULARY Willingness to Pay: the maximum price at which he/she would pay for a good. Individual Consumer Surplus: the net gain in the purchase of a good. It is the difference between the actual price and a person’s willingness to pay. Total Consumer Surplus: the sum of all the consumer surpluses of all the buyers of a good.

  3. INDIVIDUAL CONSUMER SURPLUS

  4. Buyer Willingness to pay Price paid Individual Consumer Surplus David $62 $28 $34 Maggie 55 28 27 Henry 38 28 10 Jamie 18 ---- 0 Anna 11 ---- 0 David’s CS is $62 - 28 = $34 Total Consumer Surplus equals 34 + 27 + 10 = $71 Maggie’s CS is $55 - 28 = $27 60 40 20 10 0 Henry’s CS is $38 - 28 = $10 Price =$28 Jamie Anna

  5. Now, lets suppose a sale drops the price to $14. How has Consumer Surplus changed? …..Total Consumer Surplus now equals 48 + 41 + 24+ 4 = $117 Now David’s CS is $62 - 14 = $48 Maggie’s CS is $55 - 14 = $41 60 40 20 10 0 Henry’s CS is $38 - 14 = $24 Price =$28 Now, Jamie has CS, $18 - 14 = $4 Price = $14 Anna

  6. INDIVIDUAL PRODUCER SURPLUS

  7. Just as buyers of a good would have been willing to pay more for their purchase than the price they actually pay, sellers of a good would have been wiling to sell it for less than the price they actually receive Potential Seller’s Sellers Cost Chris $5 Brandon 15 Chelsea 25 Jerusha 35 Hannah 45 Hannah 45 35 25 15 0 Jerusha’s Chelsea’s Brandon’s Chris

  8. At a price of $30, Chris, Brandon and Chelsea sell their books. Potential Seller’s Sellers Cost Chris $5 Brandon 15 Chelsea 25 Jerusha 35 Hannah 45 Hannah 45 35 25 15 0 Jerusha Price = $30 Chelsea Brandon Chris

  9. At a price of $30. Total Producer Surplus is 25 + 15 + 5 = $45 Hannah 45 35 25 15 0 Jerusha Price = $30 Chelsea’s PS, $25 -30 = $5 Brandon’s PS, $15 - 30 = $15 Chris’s PS, $5 - 30 = $25

  10. CONSUMER SURPLUS and PRODUCER SURPLUS (when there are many potential buyers/sellers)

  11. Whenever a transaction occurs in the marketplace, both consumers and producers benefit. But how much do they benefit?

  12. Suppose I am willing to pay $4 for 10 widgets. However, the price is $1.50. P This results in CONSUMER SURPLUS, which is the difference between D and P 6 5 4 3 2 1 0 $4.00 - 1.50 D $2.50 x 10 $2.50 P $25.00 Price Q 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

  13. So, Consumer Surplus is the TOTAL BENEFIT consumers receive from having a market in the good. $4.00 - 1.50 P 6 5 4 3 2 1 0 $2.50 x 10 D $2.50 $25.00 P Price Q 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

  14. Now, let’s graph this problem using an economist’s demand curve. The equation for this line would be: P = 4 - .25Q P If Q=0, then P=__ P = 4 - .25 (0) P = 4 - 0 P = 4 6 5 4 3 2 1 0 If P=0, then Q=__ 0 = 4 - .25Q+ .25Q .25Q = 4 .25 .25 Q = 16 Q 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

  15. The area between the demand ($4.00) and the price ($1.50) is the CONSUMER SURPLUS. Mathematically, P < 4 - .25Q, P > 1.50, Q > 0 Area of a triangle = 1/2bh Consumer Surplus = 1/2 (10 x 2.50) = $12.50 P 6 5 4 3 2 1 0 Q 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

  16. So….how much do producers benefit from this transaction?

  17. Suppose that a firm is willing to sell the good for $.50 but the price is $1.50 for 10 widgets. PRODUCER SURPLUS is the difference between supply curve and the price. P 6 5 4 3 2 1 0 Price $1.00 Supply (willing to sell cost) Q 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

  18. Let’s graph the supply curve on the old graph. P = .15Q If the price is set at 1.50, then1.50 = .15Q .15 .15 10 = Q P 6 5 4 3 2 1 0 S Price D Q 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

  19. Remember the area of a triangle = 1/2bh, so….. 1/2 (10 x 1.50) = $7.50 = PRODUCER SURPLUS P 6 5 4 3 2 1 0 S Price D Q 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

  20. In this case, both consumers and producers gain: CS + PS = 12.50 + 7.50 =$20.00 TOTAL BENEFIT TO SOCIETY P 6 5 4 3 2 1 0 S Price D Q 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

  21. Now, let’s suppose a tax of $.80 is added to the price of gasoline. This adds to the cost of producing the widgets. P If 0 widgets, then P = 0 + .80 = .80 6 5 4 3 2 1 0 If 10 widgets, then P = 1.50 + .80 = 2.30 S1 S Price D Q 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

  22. This changes our point of equilibrium. What happens to consumer surplus? What happens to producer surplus? P What does the pink rectangle represent? 6 5 4 3 2 1 0 The green triangle representsDEADWEIGHT loss, or the amount of sales you give up with the higher price. S1 S TAX REVENUE Price D Q 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

  23. What is the new Quantity? 4-.25Q = .15Q +.80 4-.25Q+.25Q = .15Q+.25Q+.80 4 - .80 = .40Q +.80 - .80 3.20 = .40Q Demand P = 4 - .25Q Supply P = .15Q Supply w/tax P = .15Q + .80 P 6 5 4 3 2 1 0 .40 .40 8 = Q S1 S (8, 2) P = .15(8) P = 2.00 Price D Q 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

  24. Consumers pay: $2 per unit, including the tax….. Producers receive after they pay the tax: $2 - .80 = $1.20 P 6 5 4 3 2 1 0 S1 S (8, 2) Price D Q 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

  25. What is the height for the new Consumer Surplus triangle? * 8 * 1/2 = $8.00new CS (compared to $12.50 old CS) 4 - 2.00 =2.00 P 6 5 4 3 2 1 0 S1 S Price D Q 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

  26. What is the height for the new Producer Surplus triangle? 1.20 = h 8 = b 1.820 * 8 * 1/2 =$4.80 new PS (compared to $7.50 old PS) P 6 5 4 3 2 1 0 S1 S Price D Q 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

  27. So…..using the equation 1/2bh (area of a triangle) 1/2 * 8 * 1.70 = $8.00 = New CS 1/2 * 8 * .80 = $4.80 = New PS .80 * 8 = $6.40 = Tax Amount 8.00 + 4.80 + 6.40 =$19.20 Total Benefit (compared to $20.00 old TB) P 6 5 4 3 2 1 0 S1 S Price D Q 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

  28. Compare the New Total Benefit of $19.20 to the Old Total Benefit of $20.00. Do excise taxes benefit society?

  29. Economists do not support taxes which do not benefit society, such as excise taxes. Good taxes include: property taxes, income taxes, and estate taxes.

  30. So….who pays the $.80 ? Consumers pay: $ .50 Producers pay: $ .30 In this case, consumers pay most (BUT NOT ALL) of the tax. Tax incidence depends on the elasticity of demand and the elasticity of supply. In short, whomever is less flexible in adjusting to changes in price will pay more of the tax. Consumers avoid paying the whole of the tax by buying less of the product at a lower quantity.

  31. GAINS FROM TRADE: Consumer Surplus = 1/2 * 8 * (4 - 2) = $8.00 Producer Surplus = 1/2 * 8 * (1.20 - 0) = $4.80 Tax Revenue = $. 80 * 8 = $6.40 GAINS FROM TRADE = 8 + 4.80 + 6.40 = $19.20 Deadweight Loss = 20.00 - 19.20 = $ .80 P 6 5 4 3 2 1 0 S1 S Price D Q 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

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