Question

What is consumer surplus? How is it illustrated on a demand and supply diagram?

Short answer

Consumer surplus is the difference between what a consumer is willing to pay for a good or service and what they actually pay, serving as a measure of consumer welfare. It can be illustrated on a demand and supply diagram by first plotting the downward-sloping demand curve and the upward-sloping supply curve. The area between the demand curve and the horizontal line representing the equilibrium price (P*), up to the equilibrium point, represents the consumer surplus, typically depicted as a triangle or trapezoid shape.

Step-by-step solution

Define and explain the law of demand

The law of demand is a fundamental concept in economics that states that, all other factors remaining constant, as the price of a good or service increases, the quantity demanded decreases and vice versa. In other words, there is an inverse relationship between price and quantity demanded. This relationship can be represented by a demand curve, which is a graphical representation of the demand schedule.

Define and explain the law of supply

The law of supply is another fundamental economic concept that states that, all other factors remaining constant, as the price of a good or service increases, the quantity supplied increases and vice versa. In other words, there is a direct relationship between price and quantity supplied. This relationship can be represented by a supply curve, which is a graphical representation of the supply schedule.

Understanding equilibrium in a demand and supply diagram

In a demand and supply diagram, the point where the demand curve and supply curve intersect is known as the equilibrium point. At this point, the quantity demanded equals the quantity supplied, and the market clears, meaning there is neither a surplus nor a shortage of the product. The equilibrium price (P*) is the price at which quantity demanded equals quantity supplied and the equilibrium quantity (Q*) is the quantity exchanged at the equilibrium price.

Define consumer surplus

Consumer surplus represents the difference between what a consumer is willing to pay for a good or service and what they actually pay. It is a measure of the welfare or satisfaction that consumers gain from participating in a market transaction. In other words, consumer surplus is the area between the demand curve and the price line, up to the equilibrium point.

Illustrate consumer surplus on a demand and supply diagram

To illustrate consumer surplus on a demand and supply diagram, first draw the demand curve (as a downward sloping line) and the supply curve (as an upward sloping line) on a graph. Label the axes as "Price" (vertical) and "Quantity" (horizontal). Identify the equilibrium point and equilibrium price (P*), and draw a horizontal line from the y-axis to the equilibrium point to represent the actual price paid. The area between this horizontal line and the demand curve, up to the equilibrium point, represents the consumer surplus. It is typically illustrated as a triangle or trapezoid shape.