Question

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

Short answer

Total surplus represents the overall economic welfare in a market, resulting from the sum of consumer surplus and producer surplus. On a demand and supply diagram, total surplus is illustrated as the combined area of consumer surplus (the area above the equilibrium price, below the demand curve) and producer surplus (the area below the equilibrium price, above the supply curve). This combined area is bounded by the demand curve, supply curve, and equilibrium price line, reflecting the economic welfare created by the interaction of supply and demand.

Step-by-step solution

Draw the Demand and Supply Curves

To illustrate the total surplus on a demand and supply diagram, we first must draw the demand and supply curves. The demand curve shows the quantity of a good or service that buyers are willing to purchase at different prices. The supply curve shows the quantity of a good or service that sellers are willing to produce at different prices. Draw the demand curve (D) as a downward-sloping line and the supply curve (S) as an upward-sloping line. Label each axis with Price (P) on the vertical axis and Quantity (Q) on the horizontal axis.

Determine the Equilibrium Price and Quantity

The intersection point between the demand and supply curves is the equilibrium point, which represents the equilibrium price (P*) and equilibrium quantity (Q*). This is the point where the quantity demanded by buyers equals the quantity supplied by producers. Mark the intersection point on the graph and label it as E(P*, Q*).

Identify Consumer Surplus

Consumer surplus is the difference between the maximum amount buyers are willing to pay for a good and the actual price they pay. We can find consumer surplus by looking at the area above the equilibrium price (P*) and below the demand curve (D). Specifically, consumer surplus will be the triangular area formed by the demand curve, equilibrium price line, and the vertical axis. Label this area as "Consumer Surplus."

Identify Producer Surplus

Producer surplus is the difference between the actual price producers receive for a good and the minimum amount they would be willing to accept. We can find producer surplus by looking at the area below the equilibrium price (P*) and above the supply curve (S). Specifically, producer surplus will be the triangular area formed by the supply curve, equilibrium price line, and the vertical axis. Label this area as "Producer Surplus."

Calculate Total Surplus

Total surplus is the sum of consumer surplus and producer surplus. In the demand and supply diagram, total surplus is represented by the combined area of consumer surplus and producer surplus. This is the area encompassed by the demand curve, supply curve, and the equilibrium price line. Label this combined area as "Total Surplus." By identifying the consumer surplus, producer surplus, and equilibrium in a demand and supply diagram, we can effectively illustrate the concept of total surplus and understand how it represents the overall economic welfare created by market interactions.