A supply curve can be used to measure producer surplus because it reflects

You can calculate both producer and consumer surplus by either finding the corresponding triangular areas that you can identify on a supply and demand model for any given market, or by using the respective formulas.

The supply and demand model reflects consumer and producer surplus as the inner triangular areas between the equilibrium price and the supply and demand curves respectively.

Thus, both producer and consumer surpluses can also be calculated by using the formula for the area of a right-angled triangle:

To determine producer surplus using this method, the base is the equilibrium price, and the height of the producer surplus area is the distance between the equilibrium price - PE and the y-intercept - Pmin of the supply curve. Similarly, consumer surplus can be determined by finding the triangular area where the base is the equilibrium price - PE and the height is the distance between the equilibrium price and the y-intercept - Pmax of the demand curve. Refer to Figure 4 below to see the triangular areas that represent consumer and producer surplus, respectively.

Figure 4. Consumer and producer surplus, StudySmarter Original

Consumer surplus and producer surplus formula

Producer surplus is found by multiplying the difference between the price that producers are willing to sell at and the market price by the quantity they are able to sell.

As for consumer surplus, it is calculated by multiplying a quantity by the difference between the price consumers would be willing to pay and the market price. See the formulas for producer and consumer surplus provided below.

Change in consumer surplus example

Looking at the graph and the formulas above, imagine if the market price increased from the price corresponding to the equilibrium. How would this shift affect the consumer surplus? Since the lower side of the triangular area of the consumer surplus is denoted by the market price, an increase in price would decrease the consumer surplus.

Refer to Figure 5 below for the following example. Suppose that a popular apparel brand uses imported cotton to produce their cardigans. With the usual volume of imported cotton, the brand is able to supply the cardigans at the quantity Q1 and price P1, with the initial market equilibrium marked as Eq1.

Due to an economic downturn, the country that the brand gets its cotton from has to reduce the quantity of cotton that they are able to supply and export. Now, the market equilibrium Eq2 for this brand's cardigans lies at a lower quantity Q2 and higher price P2. This decrease leads to a decrease in consumer surplus. As you can see in Figure 5, the new consumer surplus is represented by a smaller area confined by market price P2.

Figure 5. A decrease in consumer surplus. StudySmarter Original

Equally, if you were to use the formula for consumer surplus and the market price was to increase, the remaining difference (the consumer surplus) would be less than it was at a lower price. Thus, an increase in the market price would decrease the perceived benefit that consumers gather from purchasing a certain good or service.

Consumer surplus example problem

Let's dive into an example for consumer surplus calculation!

Imagine that P1 is $20, P2 is $25, initial quantity Q1 is 10, quantity after the change Q2 is 8, and the y-intercept of the demand curve is $45.

Using the consumer surplus formula, we can calculate the initial consumer surplus before the increase in market price as follows:

Imagine the supply curve shifts to the left, leading to an increased market price. We must use the new market price and new decreased quantity corresponding to the equilibrium to calculate the consumer surplus.

As you can see, the change in the market led to a reduction in consumer surplus from $125 to $80. At a higher price and lower quantity, consumers do not receive as much benefit from the transaction as they did at a lower price and higher quantity, which is reflected by a decrease in consumer surplus.

Producer surplus example problem

Let's dive into an example for producer surplus calculation!

Suppose that due to a significant decrease in income, demand for laptops shifts leftward, decreasing the equilibrium quantity and price from 20 to 15 and $1000 to $700, respectively. The y-intercept of the supply curve is $100.

For suppliers of laptops, this means that the producer surplus is now smaller than it was at a higher quantity and price, as illustrated in Figure 6 by the decrease in size of the area representing producer surplus.

Figure 6. A decrease in producer surplus, StudySmarter Original

We can also show that the producer surplus decreased by using the formula. First, lets calculate the producer surplus before the change in demand as follows:

Given that the shift in demand led the equilibrium price and quantity to decrease, we need to use the reduced quantity and price to calculate the new producer surplus.

As you can see, the decrease in equilibrium price led producer surplus to decrease from $9000 to $4500. At a lower price, producers do not get as much value out of selling their product on the market, hence the decrease in producer surplus.

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