Market Equilibrium Consumer and Producer Surplus

Market equilibrium definition

Market equilibrium is the point where demand and supply balance out, such that the quantity of a product or service demanded equals the quantity supplied. The price that matches this compromise quantity is the price at which the market can stabilize.

At equilibrium, the quantity that consumers are seeking equals the quantity that producers are willing to supply, meaning there will be just enough of a good or service to leave no surplus of it and avoid shortages. Equilibrium also reflects the price at which both producers and consumers are willing to settle.

Since the quantity of a good or service demanded equals the quantity supplied, there will be no surplus or shortage of the good at the market price.

Market equilibrium graph

When visualized on a graph, the economic equilibrium is the point of intersection between the demand and supply curves. This point of intersection reflects the compromising quantity that both consumers are willing to seek out and producers are willing to supply at a certain price. Refer to Figure 1 below to see what equilibrium looks like in a basic supply and demand model.

Producer and consumer surplus

Identifying the point of equilibrium in a given market does not only reflect the price and quantity at which the market will stabilize, but also helps determine the existing consumer and producer surplus in the market.

Producer surplus graph

Producer surplus is the difference between the price that a producer is willing to supply a product or service for versus the actual market price of that good or service. The resulting gap is the benefit that producers receive by supplying that good or service.

Producer surplus can be found on a supply and demand graph as the area confined by the equilibrium price and the supply curve, as illustrated in Figure 2 below.

Figure 2. Producer surplus, StudySmarter Original

Consumer surplus graph

Consumer surplus is the difference between the price that consumers would be willing to pay for a product and the price they actually have to pay. This difference is the marginal benefit that consumers receive by purchasing a good or service for its market price.

On a supply and demand graph, consumer surplus is illustrated as the area between the demand curve and the equilibrium price, as demonstrated in Figure 3 below.

Figure 3: Consumer surplus, StudySmarter Original

Calculating producer and consumer surplus

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: $Area=\frac{Base\times Height}{2}$$(Base\times Height)/2$

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 - P_E and the y-intercept - P_min of the supply curve. Similarly, consumer surplus can be determined by finding the triangular area where the base is the equilibrium price - P_E and the height is the distance between the equilibrium price and the y-intercept - P_max 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.

$ProducerSurplus=(Marketprice-Minpricewillingtosell)\times Quantity$

$ProducerSurplus=\frac{(Marketprice-Minpricewillingtosell)\times Quantity}{2}$

$ConsumerSurplus=\frac{(Maxpricewillingtopay-Marketprice)\times Quantity}{2}$

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.

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

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Producer surplus example problem

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