1. Consumers surplus is the difference between the maximum price a consumer is willing to pay and the actual price paid for a good. It is represented by the area under the demand curve and above the price. 2. An example is given of consumers surplus for buyers of goats at different prices. Total consumers surplus is higher when there are two goats available at a lower price rather than one goat at a higher price. 3. Producers surplus is the difference between the selling price and the producer's costs. It is represented by the area above the supply curve and below the price. Market efficiency is maximized when total surplus, the sum of consumers and producers surplus, is highest.

1. 1
Consumer Surplus, Externalities
and Deadweight Loss
Dadhi Adhikari
Kathmandu College of Management

2. 2
Consumers Surplus (CS)
• Willingness to Pay (WTP): the maximum
amount that a buyer is ready to pay
(demand curve represents WTP)
• Consumers Surplus = WTP-actual payment

3. 3
Example of CS
Buyer of Goat WTP
A 10,000
B 8,000
C 7,000
D 5,000
Suppose a seller wants to sell a goat during
Dashain festival

4. 4
Example (Cont..)
For one Goat
Buyer A will buy at 8000
CS of A = 10,000 – 8,000 = 2,000
If there are two goats
Price will set at 7,000
CS of A = 10,000 – 7,000 = 3,000
CS of B = 8,000 – 7,000 = 1,000
Total CS = 3,000+1,000 = 4,000

5. 5
Example in figure
.
No. of Goat
Price
1 2
10000
8000
7000
Initial
CS of A
CS of B
Addition
to CS for
A

6. 6
CS with Demand Curve
.
Q
P
Q1 Q2
P1
P2
Initial CS of A
CS of B
Addition to CS for A
P
P1
P2
Initial CS of A
CS of B
Addition to CS for AInitial CS of A Addition to CS for A

7. 7
Producers Surplus (PS)
• Producers surplus is the amount that is
paid to seller minus the sellers cost.
• Cost is the value of everything a seller
must give up to produce a good.

8. 8
PS with supply curve
.
Q
Q1 Q2
P
P1
P2
CS of B
Initial PS of A Addition to PS for A

9. 9
Market Efficiency
• Efficiency = Maximization of total surplus
• Total surplus = Consumers WTP- Amount paid to seller + Amount
received by seller - Cost of seller
• Total Surplus = Consumers WTP - Cost of seller

10. 10
Market Equilibrium
. Supply
Demand
Consumers
Surplus
Producers
Surplus
P
Q

11. 11
Dead Weight Loss
.
D
S
P
Pmax
A
B
D
C
E
Before Price Ceiling After Price Ceiling Change
Consumer Surplus A+C A+B B-C
Producer Surplus B+D+E D -B-E
Total Surplus A+B+C+D+E A+B+D -C-E

12. 12
Deadweight Loss
• Definition: Net loss of total surplus
• Read yourself: Deadweight loss in case fo
price floor

13. 13
Externality-Definition
• Effect of one persons action to wellbeing
of another person.
• Examples: effect of smoking, effect of
waste product of a factory to downstream
people
• Externalities-Positive and Negative

14. 14
Externality and Market Efficiency
.
Q
P
S (private cost)
D (Private value)
Here market is efficient as there is no externality
QMarket

15. 15
Negative Production Externality
.
Q
P
S (private cost)
D (Private value)
QMarketQOptimum
Loss of Surplus due to
overproduction
Social Cost

16. 16
Positive Externality in Production
.
Q
P S (private cost)
D (Private value)
QoptimumQmarket
Loss of Surplus due to
underproduction
Social Cost

17. 17
Positive externality in
consumption
. S (Private Cost)
Social Value
D (Private value)
QoptimumQmarket Q
P
Loss of Surplus due to
underproduction

18. 18
Negative Consumption Externality
. S (Private Cost)
Social Value
D (Private value)
QoptimumQmarket
Loss of Surplus due to
overproduction

19. 19
Network Externality
• If each individuals preference is affected
by the preference of others
• Bandwagon effect and Snob effect are the
example of network externality

20. 20
Bandwagon Effect
• Positive network externality in which
individual demand any goods/services
because others do so.
• In Bandwagon effect demand curve is
more flatter (more elastic)

21. 21
Snob Effect
• Desire to keep unique commodity
• Demand curve for snob effect is relatively
steeper (less inelastic)

22. 22
Reference
• Mankiw
• Pindyck and Rubinfeld