Consumer Surplus is defined as the difference between the price a customer is willing to pay for a product and the price that he actually ends up paying. When a consumer gets to purchase a good at a lower price than the price he is willing to pay, he gets more benefits creating a consumer surplus. As an example, for a necessity like food, the consumer would be willing to pay a higher price as it is a necessity. But at normal market conditions consumer can obtain food at a relatively lower price than what he is willing to pay and it creates a consumer surplus. When the utility (satisfaction) of a good falls the consumer surplus reduces as the consumer will not be willing to pay higher price.The consumer surplus can be visually represented as follows:
Image Source : Bized , (2005)
The market Price is set at $ 10 and 100 units are demanded at that price.
Therefore total revenue= $10 X 100 units = $1000
When the consumer is willing to pay more than $10 per unit, consumer experiences a consumer surplus.
Producer surplus is defined as the difference between the price at which a producer is willing to sell and the price at which actually he actually ends up selling the price. When a producer gets to sell a good at a higher price than the price he is expecting, he receives a benefit creating a producer surplus. The Producer surplus can be visually represented as follows:
Image Source :Maxwell, (n.d)
Illustration
Image Source : (Answers.com , 2010)
Calculation of Consumer Surplus
Consumer Surplus
=1/2 x Quantity Demanded at Market Price x [Highest price willing to be paid- Market Price]
=1/2 x 500 x [$10- $5]
=$1250
Calculation of Producer Surplus
Producer Surplus
=1/2 x Quantity sold at Market Price x [Market Price-Lowest Price willing to be accepted]
=1/2 x 500 x [$5-0]
=$1250
Calculation of Total Revenue
Total Revenue
=Market Price x Quantity demanded/supplied at market price
= $5 x 500
= $ 2500
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