Consumer and producer surplus
How economists measure what buyers and sellers gain from a market, using willingness to pay and cost.
FinanceA company's marketAbout 4 min: 2 reading, 2 practiceUpdated
General education, not financial advice.
- Calculate consumer surplus from willingness to pay
- Calculate producer surplus from sellers' costs
- Explain how a price change affects each surplus
Builds toward: Judge a company. Read a company's accounts, apply Graham's tests, and make a rough valuation.
A company's market: pricing power, taxes and trade: lesson 3 of 15
- A company's market
- Price elasticity of demand 6 min
- Elasticity and total revenue 5 min
- Consumer and producer surplus 4 min
- Market efficiency 5 min
- Price ceilings and floors 6 min
- Who really pays a tax 5 min
- Deadweight loss 5 min
- How tax size changes the loss 5 min
- Absolute and comparative advantage 5 min
- Why trade helps both sides 5 min
- Winners and losers from trade 5 min
- Tariffs and quotas 5 min
- What makes productivity grow 5 min
- Growth policy 5 min
- Why unemployment exists 6 min
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Pairs with any introductory economics textbook; for example N. Gregory Mankiw, Principles of Macroeconomics (6th ed.), chapter 7
What it is
Welfare economics studies how the allocation of resources affects people's well-being. Its basic measures are two kinds of surplus.
Consumer surplus = what a buyer is willing to pay − what they actually pay.
Willingness to pay is the most a buyer would pay for a good: how much they value it. Mankiw's example is an auction of a rare Elvis Presley album to four fans:
| Buyer | Willingness to pay |
|---|---|
| John | 100 |
| Paul | 80 |
| George | 70 |
| Ringo | 50 |
Bidding stops just above 80, when Paul drops out. John buys at about 80, so his consumer surplus is 100 − 80 = 20. The others pay nothing and gain nothing.
With two identical albums, the price falls to about 70 (when George drops out). John's surplus is 100 − 70 = 30 and Paul's 80 − 70 = 10: a total of 40.
Producer surplus = what a seller is paid − their cost of providing the good. Cost here means the value of everything the seller gives up, including their time.
Quick check
Tap an answer to check it.
You would pay up to 15 for a book and buy it for 9. What is your consumer surplus?
- That is the price paid
- Surplus is the difference, not the sum
Show answer
6. 15 − 9 = 6.
Why it matters
Mankiw's sellers are four house painters bidding for a job:
| Painter | Cost |
|---|---|
| Mary | 900 |
| Frida | 800 |
| Georgia | 600 |
| Grandma | 500 |
For one house, bidding falls until Grandma offers about 600, just below Georgia's cost. Grandma's producer surplus is 600 − 500 = 100.
For two houses, bidding stops at about 800, when Frida drops out. Georgia gets 800 − 600 = 200 and Grandma 800 − 500 = 300: a total of 500.
On a graph, consumer surplus is the area below the demand curve and above the price; producer surplus is the area above the supply curve and below the price.
Price changes move surplus. A lower price raises consumer surplus in two ways: existing buyers pay less, and new buyers come in. A higher price raises producer surplus: existing sellers get more, and new sellers join.
Text description
A market with a downward-sloping demand curve and an upward-sloping supply curve crossing at a price of 4 and a quantity of 8. The shaded triangle between the demand curve and the price line is consumer surplus: what buyers would have paid above what they did pay. The shaded triangle between the price line and the supply curve is producer surplus: what sellers received above their costs. Together they make total surplus.
Worked example
Five people would pay these amounts for a concert ticket: 60, 50, 40, 30, 20. The price is 35.
- Who buys? Those willing to pay at least 35: the first three.
- Consumer surplus: (60 − 35) + (50 − 35) + (40 − 35) = 25 + 15 + 5 = 45.
The price falls to 25:
- Now four buy (60, 50, 40 and 30).
- Consumer surplus: 35 + 25 + 15 + 5 = 80.
- The rise of 35 comes from the three existing buyers each paying 10 less (30) plus the new buyer's surplus (5).
Common mistake
Treating surplus as profit or as money changing hands. Consumer surplus is a measure of benefit as the buyer sees it, never paid to anyone. And a seller's cost includes the value of their time, not just what they spend.
Key terms
- welfare economics
- the study of how the way resources are shared out affects people's well-being
- willingness to pay
- the most a buyer will pay for a good
- consumer surplus
- willingness to pay minus the amount actually paid
- cost
- the value of all a seller gives up to produce a good, including their time
- producer surplus
- the amount a seller is paid minus the seller's cost
Practise the key terms
Tap a card to turn it over. 5 cards.
| Front | Back |
|---|---|
| welfare economics | the study of how the way resources are shared out affects people's well-being |
| willingness to pay | the most a buyer will pay for a good |
| consumer surplus | willingness to pay minus the amount actually paid |
| cost | the value of all a seller gives up to produce a good, including their time |
| producer surplus | the amount a seller is paid minus the seller's cost |
Practice
Work it through
Three sellers' costs of baking a cake: 8, 12 and 20. The price is 15.
- Those with costs below 15: 8 and 12
- 15 − 8
- (15 − 8) + (15 − 12)
Quick quiz
Tap an answer to check it.
In Mankiw's two-album auction, what is total consumer surplus?
- That is the one-album auction
Show answer
40: John 30 and Paul 10. With two albums the price falls to about 70.
Where is producer surplus on a supply-and-demand graph?
- That is consumer surplus
Show answer
Above the supply curve and below the price. The supply curve shows sellers' costs.
The price of a good falls. What happens to consumer surplus?
- That happens when the price rises
Show answer
It rises: existing buyers pay less and new buyers join. Both parts of the change add to buyers' benefit.
In short
- Consumer surplus = willingness to pay − price; producer surplus = price − cost.
- On a graph: consumer surplus under demand and above price; producer surplus above supply and below price.
- A lower price raises consumer surplus; a higher one raises producer surplus.
- Cost includes the value of the seller's time.
Mastery check
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Check yourself
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In Mankiw's one-house example, what is Grandma's producer surplus?
Show answer
100 (paid 600, cost 500).
Define willingness to pay.
Show answer
The most a buyer will pay for a good.
With a price of 40, buyers willing to pay 70 and 50 buy. What is total consumer surplus?
Show answer
40 (30 + 10).
Further reading
- N. Gregory Mankiw, Principles of Macroeconomics, 6th ed. (South-Western Cengage, 2012), chapter 7.
- On this site: Market efficiency.
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