In Micro Economics, Consumer and Producer Surpluses are associated with equilibrium price of a product and efficient allocation of resources to produce that product.
I will use an example to illustrate them.
Consumer Surplus
Say, market price of a pen is 5. This is its equilibrium price derived by market factors of demand and supply. Assume, you don’t have a pen and you want to buy your first pen for writing an exam. Say, you would buy it, even if it was selling for 8. So, you are happy that you need to pay only 5 to get it. Consumer surplus for you in this transaction would be 8 - 5 = 3. However, for your 2nd pen, say you would have bought it for no more than 6. So for that transaction, your consumer surplus is 6 – 5 = 1. And say, for your 3rd pen, you wouldn’t pay more than 5. Your consumer surplus for the last purchase would be 0.
Thus, total Consumer Surplus for all consumers can be calculated from the Demand Curve as sum of [all prices above equilibrium price x Quantity demanded at those prices].
Producer Surplus
Extending the same example, let’s say Total Cost (fixed and variable) for producing that pen is 2. Producer would happily sell it for any price above 2. At market price of 3, his surplus is 1 per unit sold; at price 4, it is 2 and at price 5, his surplus is 3 per unit sold.
Thus, total Producer Surplus can be derived from the Supply Curve as sum of [all prices between total cost and equilibrium price x Quantity supplied at those prices].
Also, know that, when Equilibrium Price is determined purely by Market Factors of Demand and Supply (without any external influences like production quotas, upper/lower price limits, subsidies etc), then the SUM of BOTH, Consumer and Producer Surpluses are MAXIMIZED. That is, resources used in producing that quantity corresponding to the equilibrium price, are most efficiently allocated.
I will use an example to illustrate them.
Consumer Surplus
Say, market price of a pen is 5. This is its equilibrium price derived by market factors of demand and supply. Assume, you don’t have a pen and you want to buy your first pen for writing an exam. Say, you would buy it, even if it was selling for 8. So, you are happy that you need to pay only 5 to get it. Consumer surplus for you in this transaction would be 8 - 5 = 3. However, for your 2nd pen, say you would have bought it for no more than 6. So for that transaction, your consumer surplus is 6 – 5 = 1. And say, for your 3rd pen, you wouldn’t pay more than 5. Your consumer surplus for the last purchase would be 0.
Thus, total Consumer Surplus for all consumers can be calculated from the Demand Curve as sum of [all prices above equilibrium price x Quantity demanded at those prices].
Producer Surplus
Extending the same example, let’s say Total Cost (fixed and variable) for producing that pen is 2. Producer would happily sell it for any price above 2. At market price of 3, his surplus is 1 per unit sold; at price 4, it is 2 and at price 5, his surplus is 3 per unit sold.
Thus, total Producer Surplus can be derived from the Supply Curve as sum of [all prices between total cost and equilibrium price x Quantity supplied at those prices].
Also, know that, when Equilibrium Price is determined purely by Market Factors of Demand and Supply (without any external influences like production quotas, upper/lower price limits, subsidies etc), then the SUM of BOTH, Consumer and Producer Surpluses are MAXIMIZED. That is, resources used in producing that quantity corresponding to the equilibrium price, are most efficiently allocated.
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