Effects of Price Changes on Consumer Surplus

This section examines how changes in market conditions can impact consumer surplus, using diagrams to illustrate these effects.

Impact of supply cost increases:

When supply costs increase, the market price rises, leading to a decrease in consumer surplus. This is illustrated by a shift in the supply curve, resulting in a smaller area of consumer surplus.

Example: If production costs for a good increase due to higher raw material prices, the supply curve shifts inward. This causes the market price to rise from P1 to P2, reducing consumer surplus from area ABC to area DBE.

Impact of increased market demand:

An increase in market demand can lead to a rise in consumer surplus, despite a potential increase in price. This is due to consumers' greater willingness and ability to pay for the good.

Example: When consumer preferences shift in favor of a product, the demand curve moves rightward. Even if the price increases from P1 to P2, the new consumer surplus $area GHI$ can be larger than the original $area ABC$.

Government intervention:

Government policies, such as taxes on demerit goods, can also affect consumer surplus. The impact depends on how much of the tax burden is passed on to consumers.

Highlight: The effect of government interventions on consumer surplus can vary based on factors such as price elasticity of demand and firms' strategic objectives.

Effects of Price Changes on Producer Surplus

This section explores how various market changes impact producer surplus, using diagrams to illustrate these effects.

Impact of supply increases:

When supply increases due to factors like technological improvements or lower production costs, it can lead to a decrease in price but an increase in quantity sold. This can result in an overall increase in producer surplus.

Example: An outward shift of the supply curve from S1 to S2 causes the price to fall from P to P1 and quantity to increase from Q to Q1. Despite the lower price, producer surplus may increase due to the larger quantity sold.

Effect of taxes on producers:

When taxes are imposed on producers, it can lead to an increase in market price. However, the impact on producer surplus depends on how much of the tax burden can be passed on to consumers.

Highlight: The ability of producers to pass on taxes to consumers depends on factors such as price elasticity of demand and market competition.

Changes in production costs:

A decrease in production costs can lead to an increase in producer surplus, even if market prices fall. This is because producers can sell a larger quantity at a lower cost per unit.

Example: If input costs fall, causing the supply curve to shift outward, producer surplus may grow from area P1AB to P2BC, despite the lower market price.

Page 5: Market Dynamics and Producer Surplus

The final page examines complex market interactions and their effects on producer surplus, including the impact of cost changes and taxation.

Example: An outward shift in supply due to lower input costs causes price to fall from P1 to P2, expanding producer surplus from PM AB to P2BC.

Highlight: Higher prices don't always guarantee increased producer surplus, especially when considering government taxation.

Vocabulary: Post-tax price - the price received by producers after accounting for government taxation.