Economic surplus relates to supply and demand. They are also referred to as total welfare. There can be two different types of such economic surplus, consumer surplus and producer surplus.
A consumer surplus happens when a given product or service’s price proves to be less than the greatest price level consumers would be willing to pay. This is something like an auction. Buyers go in to an auction with a maximum price amount that they are willing to pay.
Consumer surplus transpires when these buyers can obtain the product for a lesser price than their limit. This reflects a gain. Oil product prices are a real world example of potential consume surplus. When the costs for a gallon of gasoline decline to a lower amount that the consumers typically pay, the consumer realizes a profit in the form of an economic surplus.
Alternatively, a producer surplus happens as companies are able to sell their goods for more than the lowest price at which they were willing to sell. Using the same example of an auction, the auctioneer or house might have a minimum reserve on an item where they begin the bidding. The house will not accept lower than this price. They would realize a producer surplus if the auctioneer obtains a higher price than the reserve limit for the product.
This happens when the buyers keep bidding on the price of the item and thereby increase the price of the good until someone finally wins and buys it. The producer realizes more money than initially expected in this example of economic surplus. It is important to realize that producer and consumer surpluses are effectively zero sum gains. This means that the benefit of one is the loss to the other group.
There are side effects from either type of economic surplus. With a consumer surplus, this will lead to an eventual shortage in the producer’s supply. This is because supply at that price simply can not stay abreast of the demand. People like to purchase additional quantities of any product available at an attractive price point. Alternatively, a producer surplus will result typically in an overabundance of supply. This is because prices are too high for consumers willingly to purchase much of the given product.
Economic surpluses happen because of an atypical disconnect between demand and supply on a certain product. It could also result if some consumers are ready and able to pay a higher price for a good or service than are others. If instead prices were fixed on the product while all consumers anticipated paying the same price, then shortages and surpluses would not exist.
In the real world this rarely occurs. This is because different businesses and consumers have various price points at which they are willing to sell and buy. In selling items, the competition is constant to produce the most and best product for the greatest value. With prices rising and falling because of demand and supply, surplus happens on the side of the producer or the consumer.
When demand becomes too great for a given product, the vendor providing the cheapest price will sell out. This leads to general market price increases, or producer surpluses. Similarly, prices will decline if supply is high and demand is insufficient, leading to a consumer surplus. Surpluses commonly arise if the product price is set too high at first at more than consumers will pay.