|
|
|
|
Supply and demand curves can also be used to illustrate the idea of market efficiency. To understand the idea of efficiency, you must first understand the concepts of consumer and producer surplus. Consumer SurplusConsumers never spend more than they are willing to pay, and they often spend less. Economists call the difference between what consumers are willing to pay and what they do pay the consumer surplus. Consumer surplus is the psychological "profit" people get from consumption. The greater the difference between what is paid and what the consumer is willing to spend leads to a larger degree of consumer satisfaction.
More formally, the demand curve is a representation of what people are willing to pay at a given quantity. Therefore, the difference between the price and the demand curve is the consumer surplus for a given quantity. Consider the supply and demand curve below. The equilibrium market price is $5, so all three units are sold for $5. But the demand curve shows us that the first unit is worth $9 to someone. The difference between $9 and $5 is $4. Thus $4 is the consumer surplus for the first unit.
The second unit is worth $7 to someone. Since the price on the second unit is $5, the consumer surplus on the second unit is $2. The third unit is worth $5 and is sold for $5, so there is no consumer surplus on the third unit. Thus the total surplus from all three units sold is $4 + $2 + $0 = $6.
Imagine that instead of an equilibrium quantity of three units, the equilibrium quantity was 3 million units in the above graph. Instead of calculating the difference between the demand curve and the price for all 3 million units, we can estimate the consumer surplus by finding the area below the demand curve and above the price, as seen below. The area of the shaded triangle is the total consumer surplus. (Note: The area of a triangle equals one-half the base times the height.)
One of the ways to measure the benefit of a market to a society is to measure the consumer surplus. If the consumer surplus is high, we know that a large number of people are getting a "good deal" on the items they are buying in the market and vice versa.
|
