Question

Draw a supply and demand graph, and identify the areas of consumer surplus and producer surplus. Given the demand curve, how will an increase in supply affect the amount of consumer surplus shown in your diagram? Explain.

Short answer

The supply and demand graph can be plotted in the following manner:

An increase in the supply increases the consumer surplus amount by reducing the price, as shown in the diagram given below:

Step-by-step solution

Step 1. Plotting the consumer and producer surplus using demand and supply curves 

Consider the following graph, where S is the supply curve, D is the demand curve, and P is the equilibrium price:

Consumer Surplus:

• The demand curve is used to show the maximum willingness to pay for all the consumers in the market. The sum of the differences between each consumer’s maximum willingness to pay and the equilibrium price gives the consumer surplus.
• Graphically, it is the area between the demand curve and the equilibrium price (above the price line) as shown by the triangle abP.

Producer Surplus:

• The supply curve is used to show the minimum acceptable price of all the suppliers in the market. The sum of the differences between equilibrium price and each supplier’s minimum acceptable price gives the producer surplus.
• Graphically, it is the area between the supply curve and the equilibrium price (below the price line) as shown by the triangle cbP.

Thus, the consumer surplus (CS) and producer surplus (PS) are shown by the area of two triangles, which are abP and cbP, respectively.

Step 2. Effect of an increase in supply on the consumer surplus

Consider the graph given below. An increase in the supply will shift the supply curve from S to S1. As a result, the new intersection between the demand and supply curve happens at point d, and thus, the new equilibrium price is P1.

The fall in price increases consumer surplus, as the difference between their maximum willingness to pay and the new equilibrium price is higher than before. The initial amount of consumer surplus (area of triangle abP) increases with this change in price. The consumer surplus increases by the area of Pbd, marked by the gray region.