Consumer and Producer Surplus = Community Surplus

In this graph, we can see the equilibrium price of the good is $5.00 and the quantity demanded / supplied is 10 million. The blue triangle above the price line and below the demand curve represents consumer surplus. Consumer surplus is the benefit consumers get from being able to purchase a good or service at a price lower than what they were expecting to pay. In this example, we can see that at a price of $8.50, two million units of the good would be demanded. However, those consumers only have to pay $5.00, and thus they get a benefit from paying less than that which they were prepared. The same is true for the six million units demanded at a price of $6.50. Therefore, the entire blue triangle represents the total consumer surplus for this particular good.

The red triangle below the price line and above the supply curve represents producer surplus. Producer surplus is the benefit producers get from being able to receive a price for a good or service higher than what they were expecting. In this example, we can see that at a price of $1.50, two million units of the good would be supplied. However, those producers get to receive $5.00, and thus they get a benefit from receiving more than that which they were expecting. The same is true for the six million units supplied at a price of $3.50. Therefore, the entire red triangle represents the total producer surplus for this particular good.

Together with consumer surplus, we have the total economic benefit of the transaction, or community surplus (red plus blue triangles). With equilibrium quantity Q* and price P* determined by the forces of supply and demand, there is no way to make one person better off by making someone else worse off. This is called Pareto optimality and means that resources have been allocated efficiently.

This analysis allows us to see supply and demand in a different way. If we consider the supply curve to be the sum of the firms' costs of production for a good or service, we can consider how these costs apply to the community at large and call this the marginal social cost (MSC) curve. If we consider the demand curve to be the sum of consumers' utility in consuming a good or service, we can consider how these benefits apply to the community at large and call this the marginal social benefit (MSB) curve. These terms replace standard supply (S) and demand (D) in market failure analysis.