Surplus, Consumer and Producer

Surplus under Price Competition

Within any given market, price competition tends to minimize producer surplus and maximize consumer surplus. (The exact nominal value of producer and [Page 2029]consumer surplus in any given market depends on the cost and demand structures of that market.) According to economic theory, producers are forced by price competition to sell their products at marginal cost (roughly, the cost to them of producing the last item to be sold). Every consumer—even those who value a product very highly and would be willing to pay much more for it—will be able to buy that product at its marginal cost and, thus, realize substantial consumer surplus. Producers in a competitive market also realize some producer surplus, however. The amount realized will increase to the extent that the producer's average production costs are below the market price.

Price Discrimination and Surplus

Price discrimination is the sale of identical goods to different buyers at different prices. Price discrimination on the part of sellers can shift social surplus from consumers to producers. A seller who can pricediscriminate perfectly will charge each of his buyers exactly the highest price that that buyer is willing to pay. Such a seller will sell the same amount of goods as would be sold in a competitive market, but no buyer will realize any consumer surplus, and the seller will realize the maximum possible producer surplus. Perfect price discrimination, in other words, gives all the social surplus to the producers.

Perfect price discrimination is difficult to achieve, since it involves knowing each individual customer's willingness to pay. It is also difficult to maintain: It is undercut by price competition and, even where there is little competition, by arbitrage among customers. But even imperfect price discrimination transfers some social surplus from consumers to producers. This is why retailers commonly use various tactics (e.g., airline “Saturday overnight stay” rates that create differential prices for business and nonbusiness flyers) to charge their different customers prices closer to their maximum willingness to pay.

Monopoly and Surplus

A perfectly price-discriminating monopolist would, in theory, be able to sell the same number of goods as would be sold in a price-competitive market, while keeping all the social surplus on the producer's side rather than on the consumer's side. In practice, however, because price discrimination is difficult to achieve and maintain, monopolists have to set a single price for all their customers. In these circumstances, monopolists famously maximize their profits by producing fewer goods, but charging more for each. This strategy ends up splitting the social surplus. Some—more than in a competitive market—is kept by the monopolist as producer surplus. Some—less than in a competitive market—is kept as consumer surplus by those buyers who value the monopolist's product most highly. Importantly, however, the total amount of social surplus produced in this situation is less than would be produced either in a regime of perfect price competition or in a regime of perfect price discrimination. Social surplus is reduced because the monopolist's uniform high price displaces some transactions entirely. Some potential consumers are simply priced out of the market, so some goods are never sold—and no surplus is ever realized on those absent sales. (The economic loss due to these absent transactions is what economists term deadweight loss.)

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