Economic Surplus

  

There are two types of economic surplus: consumer surplus and producer surplus. As a rule, consumer surplus and producer surplus are mutually exclusive, in that what's good for one is bad for the other.

Ø  Consumer Surplus

A consumer surplus occurs when the price for a product or service is lower than the highest price a consumer would willingly pay. Think of an auction, where a buyer holds in his mind a price limit he will not exceed, for a certain painting he fancies. A consumer surplus occurs if this buyer ultimately purchases the artwork for less than his predetermined limit. In another example, let's assume the price per barrel of oil drops, causing gas prices to dip below the price a driver is accustomed to shelling out at the pump. In this case, the consumer profits with a surplus.

Ø  Producer Surplus

A producer surplus occurs when goods are sold at a higher price than the lowest price the producer was willing to sell for. In the same auction context, if an auction house sets the opening bid at the lowest price it would comfortably sell a painting, a producer surplus occurs if buyers create a bidding war, thus causing the item to sell for a higher price, far above the opening minimum.

Sellers are constantly competing with other vendors to move as much product as possible, at the best value. If demand for the product spikes, the vendor offering the lowest price may run out of supply, which tends to result in general market price increases, causing a producer surplus. The opposite occurs if prices go down, and supply is high, but there is not enough demand, consequently resulting in a consumer surplus.

Surpluses often occur when the cost of a product is initially set too high, and nobody is willing to pay that price. In such instances, companies often sell the product at a lower cost than initially hoped, in order to move stock.

When producers have a surplus of supply, they must sell the product at lower prices. Consequently, more consumers will purchase the product, now that it's cheaper. This results in supply shortages if producers cannot meet consumer demand. A shortage in supply causes prices to go back up, consequently causing consumers to turn away from the products because of high prices, and the cycle continues.