118 Putting It Together: Surplus

Summary

The goal of this module was to use the concepts of consumer surplus, producer surplus, and total economic surplus to explain the outcomes of markets for individuals, firms and society. You learned how to:

• Define and calculate consumer surplus
• Define and calculate producer surplus
• Understand total economic surplus as the sum of consumer and producer surplus
• Use the concepts of consumer, producer and total surplus to explain why markets typically lead to efficient outcomes

Examples

Consider Groupon, a website which offers significant discounts on purchases at businesses people frequently use. It’s not unusual to obtain 50% off the normal price. Why do customers like Groupon? Because it increases the consumer surplus they obtain on purchases.

Why do businesses offer Groupon campaigns? Part of it is advertising, to attract customers who aren’t familiar with those businesses. Some businesses offer regular Groupon deals. They must be doing this to increase their producer surplus (i.e., profit). This is likely part of a larger strategy, called price discrimination, which we will learn more about when we study the theory of the firm. For now, it is enough to understand that Groupon campaigns enhance producer surplus.

Since both consumer surplus and producer surplus increase, we can say that total economic (or social) surplus has increased. This is just another way of saying that transactions benefit both parties, or as economists would say, this is a more efficient outcome for society. Computing the additional consumer and producer surplus tells us by how much economic surplus has increased.