How to calculate total surplus
Understanding the economic concept of total surplus is essential for grasping the equilibrium that exists in competitive markets. Total surplus is a measure of social welfare or, more specifically, the wealth created from market transactions. In this article, we will explore the meaning of total surplus and discuss the steps involved in calculating it.
What is Total Surplus?
Total surplus is the sum of consumer surplus and producer surplus. Consumer surplus refers to the difference between what consumers are willing to pay for a good or service and what they actually pay. On the other hand, producer surplus represents the difference between what producers receive for a good or service and their marginal cost of production.
In simpler terms, total surplus is an indication of how much better off both consumers and producers are after engaging in a market transaction.
Calculating Total Surplus: A Step-by-Step Guide
1. Determine Demand and Supply Curves: To begin calculating total surplus, you first need to know the market demand and supply curves for a particular good or service. These curves represent the relationship between price and quantity demanded (demand) or quantity supplied (supply). The intersection point of these curves signifies market equilibrium, where quantity demanded equals quantity supplied.
2. Find Consumer Surplus: Once you have the demand curve, you can calculate consumer surplus by finding the area under the curve, above the equilibrium price, and confined within the range of quantity supplied. To do this, choose any point on the demand curve above-mentioned range where consumers are willing to pay more than what they actually pay (equilibrium price). The area under the curve stretching from this point to the equilibrium price and within that range represents consumer surplus.
3. Find Producer Surplus: With regard to supply curve, locate any point below equilibrium price where producers receive a higher payment than their marginal cost. The area above this point within specified range signifies producer surplus.
4. Compute Total Surplus: By adding consumer and producer surplus together, we obtain total surplus. The larger the total surplus, the more efficiency exists in the market transaction.
Graphically, total surplus is obtained as a triangle-shaped area with market equilibrium price and quantity at the base and the intersection point of demand curve with price axis acting as its vertex. This area represents the net benefits that both consumers and producers gain by participating in a competitive market.
In conclusion, understanding how to calculate total surplus is crucial for recognizing wealth created from market transactions. By determining demand and supply curves, finding consumer and producer surplus, and calculating their sum, one can gain insight into the efficiency of market processes and make informed decisions about economic policies.