In the last video, we talked about consumers, their willingness to pay, and the demand curve that shows us marginal benefit. Let's turn to producers. Remember that in a competitive market, producers are price takers.
And the supply curve gives us their willingness to accept or their willingness to sell, which reflects marginal cost. Why is it a marginal cost curve? Because the minimum that a seller will accept is what covers their costs, including opportunity cost. But that's not the price they get. The price they get is the equilibrium price, which is $3.
Let's look at the very first supplier, right over here. They're really good at making tacos and they can do it really cheaply. The first taco made costs only $1, but it's not sold for $1, it's sold for $3, all the way up to $3.
So this producer's marginal cost of a taco is $1 but their benefit from selling it is $3, the price they sold it for. They have gains from trade of $2. That's producer surplus. We could look at another supplier whose marginal cost is higher for all the reasons we discussed in the module on supply and ones we'll talk about more soon.
Their marginal cost, their willingness to sell, is $2, but they got $3. So they'll sell this taco and gain $1 of producer surplus. But this producer over here, their marginal cost is $4.
At an equilibrium price of 3, they can't cover their costs. In this simple market, it's not rational to sell something that costs you $4 for $3 on the margin. To add up all suppliers'producer surplus, we look at the area between the supply curve, that's willingness to sell, marginal cost, and the price that producers received. In this example, It's the triangle bound between $1 and $3 and 0 tacos and 100 tacos.
So applying the formula for the area of a triangle, it's 1 half times a base of 100 tacos times a height of $3 minus $1 per taco. that's this height right here and that gives us $100 of producer surplus. That's how much better off producers are because of gains from trade in this market. Now if we put consumer surplus together with producer surplus, we get economic surplus. These are the gains from trade from voluntary exchange in this market.
Together, it's the difference between marginal benefit and marginal cost. It's this whole triangle right here. The sum of consumer surplus and producer surplus. You can see it graphically because it's the difference between the demand curve, marginal benefit, and the supply curve, marginal cost. If you want to see it algebraically, we know that economic surplus is consumer surplus plus producer surplus.
Consumer surplus is marginal benefit minus price. Producer surplus is price minus marginal cost. The two price terms cancel out and what you're left with is the difference between marginal benefit and marginal cost.
Gains from trade. These are the gains from trade because it's the value produced by the exchange. I was willing to buy a taco for $4 but I was able to get it for $3. You were willing to sell it to me for $2 but you were able to sell it for $3. I gain a dollar, you gain a dollar.
This is incredibly important because far too often people think that markets are zero-sum. I can only gain if you lose. I can only get a dollar of value if you lose a dollar of value and it all adds up to zero.
That is false. It's wrong. It misunderstands the way the world actually works.
and where surplus comes from. If I'm willing to pay more for something than you're willing to accept for it, we can exchange, trade, and both be better off.