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- Learn what consumer surplus and producer surplus are and what they look to measure
1. Introduction to Consumer and Producer Surplus
In the introductory classic and dynamic modules, we explored how exchanges can take place in a market and what the outcomes for prices and quantities might be. In this module, we introduce the concepts of consumer (buyer) surplus and producer (seller) surplus, which take the analysis one step further by attempting to measure how much benefit buyers and sellers get from the trades they make in a market.
For buyers, we previously described how the idea of a "reservation price" captures how much each buyer is willing and able to pay for whatever good or service is being exchanged in the market. A simple way to think of the benefit that a particular buyer gets from making a purchase in the market is the difference between their individual reservation price and the price they actually pay for the good or service. For instance, if a buyer's reservation price is $10 but they only pay $7, then we can think of their individual gain from the trade as being the difference: $3. If we add up these individual benefits across all buyers, that's consumer surplus.
Note that the concept of producer surplus is related to, but not the same as, the idea of profit. The central difference is that producer surplus is looking at the costs and benefits of selling each individual unit, while profit is a more holistic measure that includes all costs and benefits, including costs that sellers have to pay regardless of how much they actually sell.
The idea is similar for sellers. We previously described that an individual seller's "marginal cost" is how much it costs for the seller to bring each unit of their good or service to the market. If they sell their good or service for more than their marginal cost, the difference between those two values represents their individual surplus. For example, if a seller's marginal cost is $5 but their sales price is $7, then we can calculate their individual gain from each trade as being the difference: $2. If we add up these individual benefits across all sellers, that's producer surplus.
In the next two sections, we take a look at these ideas in more detail using the classic and dynamic models.