Consumer Surplus

The difference between the maximum price that consumers are willing to pay for a good and the market price that they actually pay for a good is referred to as the consumer surplus. For example, the market price is $5, and the equilibrium quantity demanded is 5 units of the good. The

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market demand curve reveals that consumers are willing to pay at least $9 for the first unit, $8 for the second unit, $7 for the third unit, and $6 for the fourth unit. However, they can purchase 5 units of the good for just $5 per unit. Their surplus from the first unit purchased is therefore $9 — $5 = $4. Similarly, their surpluses from the second, third and fourth units purchased are $3, $2, and $1, respectively. The sum total of these surpluses equal to 10 is the consumer surplus.

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THEORY OF THE FIRM

The theory of the consumer is used to explain the market demand for goods and services. The theory of the firm provides an explanation for the market supply of goods and services. A firm is defined as any organization or individual that purchases factor of production (labor, capital, and raw materials) in order to produce goods and services that are sold to consumers, governments, or other firms. The theory of the firm assumes that the firm's primary objective is to maximize profits. In maximizing profits, firms are subject to two constraints: the consumers' demand for their product and the costs of production. This section focuses on the firm's production opportunities and cost constraints.