Measure the gains buyers and sellers receive from trade.
When buyers pay the same price that sellers receive, buyer expenditure and seller revenue both equal price times quantity traded. A tax or subsidy can create a difference between those two prices; the example here has neither. Consumer surplus is willingness to pay minus the price paid; producer surplus is the price received minus the minimum acceptable supply price. On a market diagram, total consumer surplus lies below demand and above price, while producer surplus lies above supply and below price, up to the traded quantity. Producer surplus is not profit: fixed costs still matter.
- Consumer surplus
- A buyer's maximum willingness to pay minus the price actually paid. Someone willing to pay $8 who pays $5 gains $3 of surplus; it is not an extra cash payment.
- Producer surplus
- The price a seller receives minus the lowest price at which supplying that unit is worthwhile. Receiving $5 for a unit with a $3 minimum gives $2 of surplus.
- The areas on the diagram
- Add the gains across units traded. Consumer surplus is below demand and above the price paid. Producer surplus is above supply and below the price received, up to the quantity sold.
- Surplus has two meanings
- These gains are measured in money, not unsold units. Excess supply is instead a quantity gap at a given price. Producer surplus is also not profit after all costs; fixed costs, such as rent that stays the same during the period, still have to be deducted.
Worked example: One purchase, three different amounts
A buyer would pay up to $8 for one notebook. The seller's minimum acceptable price for this unit is $3. They trade at $5, with no tax or transaction fee.
- The buyer spends $5 and the seller receives $5: expenditure and revenue for this unit are both $5.
- Consumer surplus is $8 - $5 = $3: the buyer pays less than their maximum willingness to pay.
- Producer surplus is $5 - $3 = $2: the seller receives more than the minimum acceptable supply price for this unit.
- The combined surplus is $3 + $2 = $5. It is a gain from this trade, not another payment. Seller profit cannot be inferred without the relevant cost information.
Watch out for this
Producer surplus means the stock left unsold.
Unsold excess supply is a market surplus at a given price. Producer surplus measures sellers' gain above their minimum acceptable supply prices on units sold.
Check your understanding
A buyer will pay up to $10 for one unit. Its seller would accept at least $4. They trade at $7 without taxes or fees. What are consumer surplus and producer surplus?
- $3 consumer surplus and $3 producer surplus.
- $7 consumer surplus and $7 producer surplus.
- $6 consumer surplus and no producer surplus.