Consumer and producer surplus

• What are maximized at the free market equilibrium?

  Consumer and producer surplus
• What is consumer surplus?

  • Difference between willing price and actual price
  • Based on perceived private benefit from consumption
• What area represents consumer surplus when consumers pay price P1 and demand quantity Q1?

  P1XY, the shaded triangle
• How is consumer surplus visually represented?

  Area above market price and below demand curve
• Why does consumer surplus generally decline with extra units consumed?

  Due to the law of diminishing marginal utility
• What happens to consumer surplus with inelastic demand curves?

  It gives a larger consumer surplus
• How does an increase in demand affect consumer surplus?

  • Increases consumer surplus from PQR to ABC
  • Shifts demand curve from D1 to D2
• What effect does a leftward shift in supply have on consumer surplus?

  • Decreases consumer surplus from PQR to ABR
  • Caused by higher production costs
• What is producer surplus?

  Difference between willing charge and actual charge
• How is producer surplus visually represented?

  Area below market price and above supply curve
• What causes an increase in producer surplus?

  • Shift in supply curve from S1 to S2
  • Lower average production costs
• How does an increase in demand affect producer surplus?

  • Increases producer surplus from area PQD to ABD
  • Causes market price to increase
• What is economic welfare?

  Total benefit society receives from transactions
• How is economic welfare calculated?

  By adding producer surplus and consumer surplus
• Why is economic welfare important?

  It affects the impact of government policies
• What is price discrimination in a monopoly?

  Charging different prices to different consumer groups
• What is the result of price discrimination?

  Loss of consumer welfare
• What is deadweight loss?

  Loss of economic efficiency at equilibrium
• How does monopoly power lead to deadweight loss?

  Higher prices prevent equilibrium price and quantity
• What does the yellow shaded section in the diagram represent?

  Area of deadweight loss to society