This article is a question and answer for the economics of consumer and producer surplus. The following question was presented:
I have an equilibrium chart where supply and demand intersect at 5. The price is 1$ for 1 good. The question is: assume that the cost of producing that good increases by 2$ at every possible quantity. Recalculate the consumer and producer surplus at this new equilibrium and determine if it is efficient.
My original chart has a max height of 10 and max width of 10. The supply and demand curves intersect at 5 high 5 long.
While I can't specifically answer the question above without
the graph or supply and demand equations, but we should be able to answer it by
shifting the supply curve up by $2, and re-calculating. I will demonstrate this below with an
example:
Review this old post to find what steps are necessary when
calculating consumer and producer surplus.
With this particular problem we need to know where the
supply and demand curves intersect the Y axis, and what equilibrium price and
quantity are. For the base case, we know
that demand intersects supply at a price of $5, and a quantity of 5 units. If the cost of a good increases by $2 for
every possible quantity, we know that supply is going to shift up/left. This means that we will have a new
equilibrium price and quantity.
First let’s calculate the consumer and producer surplus for
the original problem. We know that the
height of the consumer surplus triangle is 5 (10-5) and the base is 5. We use the formula for calculating the area
of a triangle to get ½*(5*5) = 12.5
We can go through the same process to get producer surplus
which is also 12.5
Now if costs increase by $2, the new intersection of supply
on the Y axis will occur at $2 (instead of $0).
The new equilibrium price and quantity will be $6 and 4. This means that the new consumer surplus will
be ½*(4*4) or 8. The new producer
surplus will be the same. When we
compare the consumer and producer surplus between these two levels, we see that
both consumer and producer surplus has declined by $4.50. This means that total surplus for this market
has declined by $9 as a result of a $2 increase in cost for each unit produced.
