Summary

1. Consumer surplus is the value that consumers receive from participating in market transactions. It is the difference between the most they would pay for something and the price they actually have to pay for it. On a supply and demand graph, consumer surplus is measured by the area under the demand curve and above the price. Producer surplus is the benefit that producers receive from participating in market transactions. It is the difference between what they sell their product for and the least they would be willing to receive to sell their product. On a supply and demand graph, producer surplus is measured by the area above the supply curve and below the price. [Section 3.1]

2. Using consumer and producer surplus, we can compute how shifts in supply and demand affect the well-being of customers and of companies. An inward shift in supply will cause consumer surplus to fall because both the increase in the equilibrium price and the decrease in the equilibrium quantity this shift causes act to reduce consumer surplus. An outward shift in supply, on the other hand, raises consumer surplus. An inward shift in demand leads to a drop in producer surplus because it decreases both the equilibrium price and quantity. Outward demand shifts have the opposite effect. [Section 3.1]

3. If the government imposes a price regulation—either a maximum price or price ceiling like rent control or a minimum price or price floor like the minimum wage—the quantities supplied and demanded will differ at the market price, resulting in either excess demand or excess supply of the good. Such regulations also create a deadweight loss that arises because some of the surplus-creating transactions that took place before the regulation was enacted do not take place in the regulated environment. A direct transfer of income from one side to the other without changing the price would be a more efficient way to help consumers and suppliers. Deadweight losses are largest when supply and demand are most elastic. [Section 3.2]

4. If the government introduces a regulation that mandates the provision of a given quantity of a good or service (a quota) or provides output itself, this action will change the market and create a deadweight loss, just as a price regulation does. These actions do not create excess demand or supply, though, because prices are able to adjust and clear the market. [Section 3.3]

5. Taxes reduce output and raise price. In doing so, they reduce consumer and producer surplus but generate tax revenue. The revenue they generate is less than the damage they do to surplus, and the difference is the deadweight loss of the tax. The concept of tax incidence tells us who really bears the burden of a tax: It does not matter who actually pays a tax by law. All that matters is the elasticities of supply and demand. The more elastic side of the market will bear less of the burden because it can more easily shift away from the taxed good. [Section 3.4]

6. Subsidies increase both consumer and producer surplus relative to the free-market equilibrium. They still create a deadweight loss, though, because the outlay cost of the subsidy exceeds the amount by which it increases the surplus of the two groups. [Section 3.5]