AAEC 3315 Agricultural Price Theory

1. AAEC 3315Agricultural Price Theory Chapter 11 Market Equilibrium, Consumers’ Surplus, and Producers’ Surplus

2. Objectives • To learn: • How Consumers’ and Producers’ Surplus are determined in a market . • How Consumers’ and Producers’ Surplus change with changing market conditions.

3. Market Equilibrium • Earlier, we saw that market equilibrium occurs when the quantity of a good offered by sellers at a given price equals the quantity buyers are willing and able to purchase at that same price. • That is, market equilibrium occurs at price equals P* and quantity equals Q*. P S P* D Q Q*

4. Consumers’ Surplus Consumers’ Surplus is defined as the difference between what the consumer would be willing to pay and what the consumer actually has to pay.

5. Consumers’ Surplus • Note that for buying Q1 units, consumer is willing to pay P1/unit of product. • For buying Q2 units, consumer is willing to pay P2/unit of product. • But at market equilibrium, the consumer buys Q3 units of the product for P3/unit of product. • Thus, at the equilibrium price of P3/unit of product, consumer actually ends up paying less than what he is willing to pay. • This difference is called the Consumers’ Surplus. P S P1 P2 P3 D Q Q3 Q1 Q2

6. Consumers’ Surplus • In general, Consumers’ Surplus can then be calculated as the area under the demand curve and above the price level, i.e., the shaded area. P S P D Q Q

7. Producers’ Surplus Producers’ Surplus is defined as the dollar amount by which firms benefit by producing their profit maximizing level of output. In other words, Producer Surplus is price of a good minus the marginal cost of producing it.

8. Producers’ Surplus • Note that for selling Q1 units, producer is willing to accept P1/unit of product. • For selling Q2 units, producer is willing to accept P2/unit of product. • But at market equilibrium, the consumer sells Q3 units of the product at P3/unit of product. • Thus, at the equilibrium price of P3/unit of product, producer actually ends up receiving more than what he is willing to accept. • This difference is called the Producers’ Surplus. P S P3 P2 P1 D Q Q1 Q2 Q3

9. Producers’ Surplus • In general, Producers’ Surplus can then be calculated as the area above the supply curve and below the price level, i.e., the shaded area. P S P1 D Q Q1

10. Consumers’ and Producers’ Surplus • Consumers’ Surplus is given by the area under the demand curve and above the price level. • Producers’ Surplus is given by the area above the supply curve and below the price level. • So the Total Surplus is the sum of Producers’ Surplus and the Consumers’ Surplus, and is the amount by which the Society is benefited. P S P1 D Q Q1

11. Per Unit Production TaxImpacts on Consumers’ and Producers’ Surplus S1 • Per unit production tax shifts the supply curve from S to S1. Resulting in a change in the equilibrium price from P1 to P2 and equilibrium quantity from Q1 to Q2. • Before tax CS = abP1 After tax CS = adP2 Tax decreased CS • Before tax PS = cbP1 After tax PS = edP2 Tax decreased PS • Before tax Total Surplus = abc After tax Total Surplus = ade Tax decreased Total Surplus • Society overall is worse off due to the production tax P S a d P2 P1 b e D c Q Q1 Q2

12. Increase in IncomeImpacts on Consumers’ and Producers’ Surplus • Increase in income shifts the demand curve from D to D1. Resulting in a change in the equilibrium price from P1 to P2 and equilibrium quantity from Q1 to Q2. • Initial CS = abP1 Later CS = edP2 Not sure if CS increased or decreased. • Initial PS = cbP1 Later PS = cdP2 Increase in PS • Initial Total Surplus = abc Later Total Surplus = edc An increase in Total Surplus • Society overall is better off due to an increase in consumer income. P e S a d P2 b P1 D1 D c Q Q1 Q2

13. Some Other Scenarios • Review the following scenarios on your own • Technological development • Increase in population • Decrease in population • Increase in input prices • Decrease in input prices