Microeconomics Essentials: Consumer Surplus, Producer Surplus, and Total Gains from Trade

Willingness to Pay and Cost: The Building Blocks of Surplus

Willingness to pay (WTP) is the maximum amount a buyer would pay for one additional unit of a good. It is measured in dollars per unit and is interpreted as the buyer’s marginal benefit for that unit.

Cost (in this context) is the minimum amount a seller must receive to be willing to supply one additional unit. It is measured in dollars per unit and is interpreted as the seller’s marginal cost (including opportunity cost) for that unit.

Surplus comes from the gap between what buyers are willing to pay and what sellers must receive. When a unit trades at market price P, two comparisons happen for that unit:

• Buyer side: if WTP > P, the buyer gains value beyond what they pay.
• Seller side: if P > cost, the seller receives more than the minimum needed to supply.

Visual Definition on a Graph

Consumer Surplus (CS): Area Under Demand Above Price

On a standard price–quantity graph, the demand curve shows WTP for each unit. If the market price is P*, then for every unit purchased up to Q*, the buyer’s WTP is given by the height of the demand curve, while the buyer pays P*.

Consumer surplus is the total of (WTP − P*) across all units bought. Graphically, it is the area between the demand curve and the horizontal line at price P*, from 0 to Q*.

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Price
  |
  |\   Demand (WTP)
  | \ 
P*|--\----------  price line
  |   \ 
  |    \ 
  +-----\---------------- Quantity
        Q*

Consumer Surplus = area under demand and above P*, up to Q*

Producer Surplus (PS): Area Above Supply Below Price

The supply curve shows the minimum price required to supply each unit (the unit’s cost). If the market price is P*, then for every unit sold up to Q*, the seller receives P* but incurs a cost given by the height of the supply curve.

Producer surplus is the total of (P* − cost) across all units sold. Graphically, it is the area between the horizontal price line at P* and the supply curve, from 0 to Q*.

Price
  |
P*|----------/--  price line
  |         / 
  |        /   Supply (cost)
  |       / 
  |      / 
  +-----/------------------- Quantity
       Q*

Producer Surplus = area above supply and below P*, up to Q*

Total Surplus (Gains from Trade)

Total surplus (TS) is CS + PS. It measures the total gains from trade created in the market at the given price and quantity. Graphically, it is the area between the demand curve and supply curve from 0 to Q*.

For each unit traded, the gain from trade is WTP − cost. Summing across all traded units yields total surplus.

Step-by-Step Area Calculation with a Linear Example

Use a simple linear demand and supply with price in dollars and quantity in units:

• Demand: P = 100 − 2Q
• Supply: P = 20 + Q

Step 1: Find the Market Outcome (P*, Q*)

At the traded quantity, buyers and sellers agree on a single price, so set demand equal to supply:

100 − 2Q = 20 + Q

80 = 3Q so Q* = 80/3 ≈ 26.67

Plug back in to get price:

P* = 20 + Q* = 20 + 80/3 = 140/3 ≈ 46.67

Step 2: Compute Consumer Surplus as a Triangle

For a linear demand curve, consumer surplus is a triangle with:

• Base: Q*
• Height: (choke price on demand) − P*

The choke price is the demand intercept at Q = 0: P = 100.

Height = 100 − 140/3 = 160/3 ≈ 53.33

So:

CS = (1/2) × base × height = (1/2) × (80/3) × (160/3) = 6400/9 ≈ 711.11

Interpretation: across all units purchased, buyers collectively gain about $711 of value beyond what they pay.

Step 3: Compute Producer Surplus as a Triangle

For a linear supply curve, producer surplus is a triangle with:

• Base: Q*
• Height: P* − (supply intercept at Q = 0)

The supply intercept at Q = 0 is P = 20.

Height = 140/3 − 20 = 80/3 ≈ 26.67

So:

PS = (1/2) × (80/3) × (80/3) = 3200/9 ≈ 355.56

Interpretation: across all units sold, sellers collectively receive about $356 above the minimum needed to cover costs.

Step 4: Compute Total Surplus

TS = CS + PS = 6400/9 + 3200/9 = 9600/9 = 1066.67

Graphically, this equals the area between demand and supply from 0 to Q*.

Optional Check: Rectangle + Triangle Reasoning

Sometimes it helps to decompose areas:

• Buyer total value (gross benefit) is the area under demand up to Q*.
• Buyer total spending is the rectangle P* × Q*.
• CS = (area under demand) − (P* × Q*).

Similarly:

• Seller total revenue is P* × Q*.
• Seller total variable cost is the area under supply up to Q*.
• PS = (P* × Q*) − (area under supply).

What Surplus Measures—and What It Does Not

What Surplus Measures

• Consumer surplus measures how much buyers benefit from being able to purchase at the market price rather than their maximum willingness to pay.
• Producer surplus measures how much sellers benefit from receiving the market price rather than the minimum price needed to supply (their cost).
• Total surplus measures the total gains from trade: how much value is created when units with WTP > cost are traded.

What Surplus Does Not Measure

• It is not the same as “revenue” or “profit.” Producer surplus is not accounting profit; it is revenue minus variable cost (as represented by the supply curve), and it does not automatically subtract fixed costs.
• It does not directly measure fairness or equality. A market can have high total surplus while distributing gains unevenly between buyers and sellers.
• It does not automatically include external effects. If production or consumption imposes costs/benefits on non-participants, the surplus computed from demand and supply alone can misstate overall social gains.
• It depends on the demand and supply curves being accurate measures of WTP and cost. If WTP is distorted (e.g., misinformation) or costs omit important opportunity costs, measured surplus can be misleading.

Exercises: How Shifts Change CS, PS, and Total Surplus

Exercise 1: Demand Increase (Qualitative)

Suppose demand shifts outward (buyers become willing to pay more at each quantity), while supply is unchanged.

• On a graph, draw the original demand D0 and new demand D1 to the right/up.
• Mark the original equilibrium (P0, Q0) and new equilibrium (P1, Q1).

Questions:

• Does Q rise or fall?
• Does P rise or fall?
• What happens to consumer surplus? (Consider that price rises but buyers’ WTP also rises.)
• What happens to producer surplus?
• What happens to total surplus?

Exercise 2: Supply Increase (Qualitative)

Suppose supply shifts outward (costs fall), while demand is unchanged.

Questions:

• Does P rise or fall?
• Does Q rise or fall?
• What happens to consumer surplus?
• What happens to producer surplus? (Price falls but costs are lower and quantity is higher.)
• What happens to total surplus?

Exercise 3: Compute Surplus Before and After a Shift (Quantitative)

Initial curves:

• Demand: P = 90 − Q
• Supply: P = 10 + Q

After a change in buyer preferences, demand becomes:

• New demand: P = 110 − Q

Tasks:

• Find (P*, Q*) initially and after the shift.
• Compute initial CS, PS, and TS using triangle areas.
• Compute new CS, PS, and TS.
• Compare: which surplus changes more, and why?

Exercise 4: Identify the Area (Graph Reading)

You are given a graph with linear demand and supply and a marked market price P* and quantity Q*.

Tasks:

• Shade consumer surplus and label it CS.
• Shade producer surplus and label it PS.
• Shade total surplus (the area between demand and supply up to Q*) and label it TS.
• Explain in one sentence what each shaded region represents in terms of WTP, price, and cost.

Exercise 5: Mixed Shifts and Ambiguous Effects

Demand shifts inward (lower WTP) and supply shifts outward (lower costs) at the same time.

Questions:

• Is the change in equilibrium price necessarily known without magnitudes?
• Is the change in equilibrium quantity necessarily known without magnitudes?
• Even if price is ambiguous, what is one reason total surplus could rise? What is one reason it could fall?