Question

a. Show on a demand supply graph how consumer surplus and producer surplus is defined.

b. In general to evaluate welfare effects we need to consider the welfare of groups of individuals. What problem does consumer surplus pose in this regard?

c. There are two firms in an economy facing a upward sloping supply curve in a perfectly competitive setting. Show graphically how you would nd the total producer surplus in the economy.

Answer 1

a)

Consumers surplus is the difference between Consumers willingness to pay and what are they actually paying. On the graph, Consumers surplus is the area below the demand curve and above the price Consumers pay.

Producers surplus is the difference between the price at which producers are selling their good and producers' willingness to sell. On the graph, producers surplus is the area below the market price and above the supply curve.