A2 Markets & Market Systems

Consumer & Producer Surplus

In this note we recap the concepts of consumer and producer surplus that were covered as part of the AS economics course and we then use them to help analyse some of the welfare effects of the market structures visited in previous notes.

Recap on the ideas

Consumer surplus is the difference between the total amount that consumers are willing and able to pay for a good or service (indicated by the demand curve) and the total amount that they actually pay (the market price).
Producer surplus is the difference between what producers are willing and able to supply a good for and the price they actually receive. The level of producer surplus is shown by the area above the supply curve and below the market price.

Consumer & Producer Surplus Economic efficiency

Economic efficiency is achieved when an output of goods and services is produced making the most efficient use of our scarce resources and when that output best meets the needs and wants and consumers and is priced at a price that fairly reflects the value of resources used up in production. There are two main types of efficiency - static and dynamic.

Economic efficiency
Price Discrimination and consumer & producer surplus

Price discrimination occurs when a firm charges a different price to different groups of consumers for an identical good or service, for reasons not associated with the costs of supply. Price discrimination is common in any market where firms have a degree of pricing power over different groups of consumers. But what are the possible implications for consumers and producers in terms of consumer and producer surplus? Is price discrimination something that economists should be supporting in terms of the behaviour of businesses and final outcomes in different markets?

Pure (1st degree) discrimination

With 1st degree price discrimination the firm is able to perfectly segment the market so that the consumer surplus is removed and turned into producer surplus. Thus there is a clear transfer of welfare from consumers to producers. This is shown in the next diagram.

Pure (1st degree) discrimination

Third degree (or multi-market) price discrimination is the most frequently found form of price discrimination and involves charging different prices for the same product in different segments of the market. The key is that third degree discrimination is linked directly to consumers’ willingness and ability to pay for a good or service. It means that the prices charged may bear little or no relation to the cost of production. Clearly the price elasticity of demand is the key factor determining the pricing decision for producers for each segment of the market.

The market is usually separated in two ways: by time or by geography. For example, exporters may charge a higher price in overseas markets if demand is estimated to be more inelastic than it is in home markets. There is more consumer surplus to be exploited when demand is insensitive to price changes. This is demonstrated in the following diagram:
Third degree (or multi-market) price discrimination

Author: Geoff Riley, Eton College, September 2006

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A2 Markets & Market Systems

Consumer & Producer Surplus

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