Every latte you sell leaves two people better off: you, and a customer who would have paid more. All season you've kept score for one of them. This week you add up the whole pie.
Learning objectives. After this week you can (1) compute consumer, producer and total surplus; (2) explain why pricing at marginal cost is efficient; and (3) tell a transfer from a deadweight loss.
Remember this: a transfer moves the pie between people. Deadweight loss shrinks it.
1) Surplus on both sides
Consumer Surplus = Willingness to Pay − Price
Producer Surplus = Price − Marginal Cost (in total: revenue − variable cost)
A customer who would pay $6.00 buys your $5.00 latte: consumer surplus $1.00. With a $1.20 MC latte, producer surplus is $3.80. Total surplus is the sum, $4.80 of value from one cup. Every voluntary trade where willingness to pay is above marginal cost creates surplus.
2) Efficiency
A market is efficient when every cup worth more to a buyer than it costs to make gets made. Perfect competition gets there because price is pushed down to marginal cost. Efficiency measures the size of the pie, not whether the slicing is fair.
3) Deadweight loss
At $4.40 you would sell 340 lattes; at $5.00 you sell 300. MC latte: $1.20.
- Transfer: the 300 who stay pay $0.60 more each, so $180 moves from them to you. The pie is the same size.
- Lost trades: the 40 who walk valued a cup between $4.40 and $5.00, about $4.70 on average, and each cost $1.20 to make. Lost surplus ≈ 40 × ($4.70 − $1.20) = $140 a day that nobody collects: deadweight loss.
The hike still adds $180 − 40 × ($4.40 − $1.20) = $180 − $128 = $52 to your till. Your best price and society's are different places. Pricing past your own MR = MC point loses both: your profit and total surplus.
4) What wins surplus back
More competing shops on your street push markups toward cost. A student discount sells cups to buyers one price would lose. Shops that differ in beans and ambiance create value a one-price commodity market would not, so some markup pays for variety customers want. A price ceiling below equilibrium does the opposite: cups buyers value above their cost never get brewed. For a whole day, your Daily Report gives producer surplus as Revenue − COGS − Wages: Revenue $1,420, COGS $310 and Wages $480 leave $630. Rent stays out, because fixed costs don't change with the day's trades.
Quick self-check
(a) A customer would pay $5.50 for your $5.00 latte, and your MC latte is $1.20. Consumer, producer and total surplus? (b) A price rise makes 300 staying buyers pay $0.50 more each. Transfer or deadweight loss? (Answers: $0.50, $3.80 and $4.30; a $150 transfer.)
Common mistakes
- Calling a transfer a loss. Only the lost trades are deadweight.
- Putting rent in producer surplus. Use variable costs only.
- Equating efficiency with fairness. Welfare measures the pie, not the slicing.
This week in the arena
From one Daily Report, compute producer surplus: Revenue − COGS − Wages. Then compare your latte price with your MC latte line; the gap is your markup per cup. Think about the people who walked past at that price but valued a latte above its MC. That is the slice of the pie nobody got.