Question

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

Short answer

Total surplus is the combined measure of consumer surplus and producer surplus in an economy, representing the overall welfare and efficiency of a market. On a demand and supply diagram, total surplus is illustrated as the sum of the areas of two triangles: one for consumer surplus (the area above the equilibrium price and below the demand curve) and the other for producer surplus (the area below the equilibrium price and above the supply curve). The total surplus is calculated by finding the area of each triangle using the formula \(A = (1/2)bh\) and then adding them together.

Step-by-step solution

Define Total Surplus

Total surplus is the combined measure of consumer surplus and producer surplus in an economy. Consumer surplus is the difference between the price that consumers are willing to pay and the price they actually pay for a good, while producer surplus is the difference between the price at which producers are willing to sell a product and the price they actually receive. The total surplus measures the overall welfare and efficiency of a market, demonstrating both the gains for consumers and producers participating in the market.

Visualize Demand and Supply Diagram

To illustrate total surplus on a demand and supply diagram, we need to draw the demand curve (D), the supply curve (S), and the market equilibrium point (E), where the demand and supply curves intersect. The demand curve is downward sloping to represent the relationship between price and quantity demanded: as price decreases, consumers will demand more of a product. The supply curve is upward sloping to represent the relationship between price and the quantity supplied: as price increases, producers will supply more of a product.

Identifying Consumer and Producer Surplus on the Diagram

In the demand and supply diagram with the demand curve (D) and the supply curve (S), create a horizontal line at the market equilibrium price (P*) that intersects both curves. The consumer surplus is illustrated as the area above the equilibrium price (P*) and below the demand curve (D), while the producer surplus is the area below the equilibrium price (P*) and above the supply curve (S).

Calculating Total Surplus from the Diagram

To calculate total surplus, we need to determine the areas of consumer surplus and producer surplus. These areas form two triangles: one for consumer surplus and the other for producer surplus. The area of a triangle can be calculated as \(A = (1/2)bh\), where \(A\) is the area, \(b\) is the base, and \(h\) is the height. Calculate the area of the consumer surplus triangle and the producer surplus triangle separately. The height of the triangles will be determined by the equilibrium price (P*), and the base will be the difference between the quantities on the demand and supply curves associated with this price level (Q* - 0). Finally, add the areas of the consumer surplus and producer surplus triangles to find the total surplus.

Conclusion

Total surplus is the sum of consumer surplus and producer surplus. It reflects the overall welfare and efficiency of a market, which can be represented and calculated on a demand and supply diagram, showing both the benefits and the costs of consuming and producing a particular good.