Evaluating The Market Equilibrium

Figure 7-7 shows consumer and producer surplus when a market reaches the equilibrium of supply and demand. Recall that consumer surplus equals the area above the price and under the demand curve and producer surplus equals the area below the price and above the supply curve. Thus, the total area between the supply and demand curves up to the point of equilibrium represents the total surplus from this market.

Is this equilibrium allocation of resources efficient? Does it maximize total surplus? To answer these questions, keep in mind that when a market is in equilibrium, the price determines which buyers and sellers participate in the market. Those buyers who value the good more than the price (represented by the segment AE on the demand curve) choose to buy the good; those buyers who value it less than the price (represented by the segment EB) do not. Similarly, those sellers whose costs are less than the price (represented by the segment CE on the supply curve) choose to produce and sell the good; those sellers whose costs are greater than the price (represented by the segment ED) do not.

These observations lead to two insights about market outcomes:

Figure 7-7

Consumer and Producer Surplus in the Market Equilibrium. Total surplus— the sum of consumer and producer surplus—is the area between the supply and demand curves up to the equilibrium quantity.

Price

Equilibrium price

Price

Equilibrium price

Equilibrium quantity

Quantity

Equilibrium quantity

Quantity

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