Back to Overview
Review Question



Producers' and Consumers' Surplus Illustrated

The producers' and consumers' surpluses are illustrated with supply and demand curves in the figure below. The total value to consumers of quantity Q is represented by areas A+B+C. Because the consumers must pay B+C, only the area A is surplus for them. Producers get revenue of B+C. B is their surplus because only payments of C are needed to attract the resources necessary to produce quantity Q.

Producers' and Consumers' Surpluses

The concepts of consumers' and producers' surpluses are tools that can help analyze many situations. For example, is there any temptation for sellers to gang up on buyers? If sellers could raise the price, would they transfer some of the consumers' surplus to themselves? They would, and the graph below illustrates why. The consumers' surplus at price Pc is A+B+D. The producers' surplus at this price is C+E. By raising price to Pm, sellers cause the consumers' surplus to shrink to the area A. Area B is transferred from consumers to producers, but producers lose area E. If area B is greater than area E, this move benefits producers. The new producers' surplus is C+B. If sellers gang up on buyers, they are no longer price takers. Rather, the sellers leave the supply curve and search along the demand curve for the best deal. As a result, such behavior is called "price searching."

Capturing Consumers' Surplus

It is easiest for sellers to restrict output and raise price when there are very few sellers and many buyers. When there is monopoly, which means there is only one seller, economists expect the seller to act in this way. With many sellers, coordination of decisions becomes difficult (for the same reason that the problem of the commons can exist) and output restrictions become unlikely.

Alternatively, buyers can gang up on sellers and extract producers' surplus. They must restrict purchases to drive the price down. Again, this behavior is likely only when there are very few buyers and many sellers. When there is only one buyer, a monopsonist, economists expect it to restrict purchases.

What is good for the individual is not necessarily good for the group. Notice that the process of transferring the value of area B from consumers to producers in the second graph above causes consumers to lose area D and producers to lose area E, and no one gets this lost value. In the process of increasing their surplus by seizing area B, producers cause the value of total surplus to shrink. There is a conflict here between the interests of producers and society as a whole. This loss of value, which is not offset elsewhere in the system, is the essence of the economist's case against monopoly.

Back to OverviewReview QuestionQuiz
Copyright Robert Schenk