Throughout this chapter we have assumed that individuals actually want to trade goods for money. The benefits that accrue to individuals depend on what value they place on the good being traded. We already know that a consumer will not buy a unit of a good unless the price on that unit is lower than or equal to her reservation price. The reservation price is the marginal value she places on that unit of the good. Similarly, a firm will not produce a good if the additional value that the firm can obtain from selling that unit does not exceed its cost of producing the unit. But sometimes consumers and sellers do even better. A consumer may pay less than her reservation price, or a seller may get more than the additional production costs for a good. In each case, a surplus value is realized. Economists classify these as consumer's (or buyer's) surplus and producer's (or seller's) surplus.

Consumer's Surplus

Suppose every day when you go to lunch you purchase a soft drink for $1.00. Clearly, your reservation price is at least $1.00, or you would not buy that drink. If however, one day you find that the store is having a sale, and soft drinks are only 75 cents that day, you have obtained an additional surplus of 25 cents. It is as if someone gave you 25 cents when you bought that soft drink. That 25 cents is part of the consumer's surplus you enjoy when you purchase soft drinks.

Consumer's surplus for each unit bought by consumers is the difference between the reservation price the consumer had for that unit and the price the consumer actually had to pay. Since the reservation price is how much the consumer valued that unit, consumer's surplus is the excess value a consumer enjoys from purchasing a unit of a good at the market price. Under some strict assumptions, consumer's surplus can be represented as the area under the demand curve but above the market price. Even without the strict assumptions, this area approximates the true consumer's surplus. In figure 2.14, the consumer's surplus is the triangle abc. In fact, this triangle is the gains from trading money for the goods that consumers in this market enjoy You can think of consumer's surplus as excess satisfaction.

Clearly, consumer's surplus increases as market price falls. The quantity demanded increases, the price paid per unit gets smaller, and the area of the triangle under the demand curve and over price gets larger. Without consumer surplus there is a lot less incentive for trade to take place. If every consumer were charged his or her reservation price for each unit of a good, it would be as if they were trading two five dollar bills for a ten dollar bill. Although no one is losing anything, no one is gaining anything either. When a consumer enjoys excess value however, when the price is below the reservation price, it is as if he or she traded one five dollar bill for a ten dollar bill. There is a real, and often measurable, benefit.

Producer's Surplus

The producer's surplus is the seller's counterpart of the consumer's surplus. It is the amount by which the price the seller gets for each unit sold exceeds the additional cost of providing that unit. In figure 2.14 producer's surplus is the triangle cdb. Later we will term this quasi-rent, but for now think of producer's surplus as the benefits the firm gets from selling the good. Notice that as we move downward to the left on the supply curve, the sellers surplus falls, and it increases if we move in the opposite direction. Thus, sellers do better if the demand for a good is high, or they are guaranteed a high price.

The producer's surplus comes about because firms can often sell units at prices higher than at which they would be willing to sell them. For example, a car dealer may be willing to sell a Jeep Cherokee at $14,000 but after bargaining with a customer manages to get a price of $14,500. In this case, the producer's surplus for that Jeep is $500.

Comparative Statics and Surplus Values

One use of surplus value analysis is to measure the effects of shifts in the demand and supply curves. Figure 2.15 shows a market which experiences an increase in supply from S to S'. Consumer's surplus increases from triangle abc to triangle ade. Seller's surplus, however, has an uncertain change, from triangle cbf to triangle edg. Because the shift shown is parallel, seller's surplus increases. But if the change is not parallel, for example a pivot as in figure 2.16 the change is not clear. Sellers lose quadrangle cbge in surplus value, but gain triangle fgd.
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Analogous arguments hold for shifts in demand.
In figure 2.17 the demand curve has a parallel shift from D to D'. Consumer's surplus increases from triangle abc to deg. Seller's surplus also increases from triangle cbf to gef. But if instead demand pivots, as in figure 2.18, while we have the unequivocal increase in producer's surplus, the change in consumer's surplus is uncertain. Here consumers gain triangle aeb, but lose quadrangle gecb.

In all cases of shifting demand and supply curves, what happens to consumer's and seller's surpluses depends on how the curves shift, how much they shift, and the slopes of both curves. But one thing is clear. Policies that shift these curves have real effects on surplus values (hence social welfare), and not just on equilibrium price. Additionally, many government policies in one way or another shift surplus values between consumers and producers.

An example of this is agricultural price supports. For dairy products, as one case, the government promises that producers will receive at least a certain price, and will buy milk directly from the producers if the market will not pay that price. Producers, obviously, will not sell their milk elsewhere if the price offered is less than the government price support. The government ends up buying a lot of milk, which it makes into cheese and stores. Producers are better off, but consumers are worse off as well.

Figure 2.19 illustrates the market. In an unfettered equilibrium the market price would be P₁ with consumers enjoying a surplus value of the triangle abP₁ and producer's surplus equaling the triangle cbP₁. Quantity sold equals Q₁. With the price supports at P₂, sellers will not sell their milk on the market unless they get that price, so buyers also must pay P₂, and want only Q_b. Sellers want to sell Q_s at the higher price, so the government purchases the difference.

Sellers are better off with price supports. Producer's surplus increases to ceP₂. But consumers are worse off. Consumer's surplus falls to adP₂. And much of the seller's gain is at consumer's expense. The rectangle P₂dfP₁ represents the transfer of consumer's surplus to sellers from the price supports. Additionally, because they are consuming less, buyers lose dfb in surplus value. The remaining portion of increased seller's surplus, deb, as well as the triangle dfb, would come from government subsidies.