Market equilibrium and consumer and producer surpluses

After you have worked through this section of the learning unit, you should be able to:

  • explain and illustrate with the aid of a diagram why total consumer surplus and total producer surplus is maximised at the market equilibrium point

Market equilibrium exists where the quantity demanded is equal to the quantity supplied. In the diagram below, this is indicated at point E. At point E, the equilibrium price is R4, and the equilibrium quantity is 300.

The consumer surplus and producer surplus are also indicated in the above diagram.

Which triangle represents the consumer surplus at equilibrium?

Total consumer surplus at a market price of R4 is represented by the triangular (4-8-E), area between the demand curve, which indicates the maximum prices buyers are prepared to pay, and the horizontal line, which indicates the market price of R4.

Which triangle represents the producer surplus at equilibrium?

Total producer surplus at a market price of R4 is represented by the grey triangular area (0-4-E), between the supply curve, which indicates the minimum prices suppliers are prepared to accept, and the horizontal line (which indicates the market price of R4) that they are actually receiving.

An important point to note about the consumer and producer surpluses at equilibrium is that it is the point where the total surplus (consumer surplus + producer surplus) is maximised. Given the demand and supply curve at any other output or price level, the consumer and producer surpluses will be less.

Take an output level of 240 units in the diagram below. At this output level of 240 units, the consumer surplus is the dark grey area, while the producer surplus is the light grey area. As indicated in the diagram, the consumer surplus and producer surplus at an output level of 240 units are less than the consumer and producer surpluses at an output level of 300 units. By increasing production from 240 to 300, both the consumer surplus and producer surplus increase.

In the above diagram, the consumer surplus lost at a quantity of 240 is the white triangle (diagram),, while the producer surplus lost is the black triangle (diagram),.

At an equilibrium such as E, it is impossible to further increase the total producer and consumer surplus, and it is therefore the point where the consumer and producer surpluses are maximised.

Do the following activity to see if you understand this section on market equilibrium and consumer and producer surpluses:

[Activity]