Consumer surplus and Producer surplus are terms that are used often in economics in the discipline of economics surplus. While the meaning of the two can be understood from the words themselves, a more accurate definition would be found in economic text books, which define them as below:-
Consumer surplus is the difference between the total amount that consumers are willing and able to pay for any goods or services and the total amount that they actually pay. Producer surplus is the difference between the price at which producers are willing and able to supply any goods or services and the price that they actually receive. The price that consumers are willing and able to pay is represented by the demand curve. The price that they actually pay is the going market price for that goods or services. When consumer demand and producer supply are balanced and when one can satisfy the other at quantities and prices that meet the expectation of the other, while at the same time making the best use of scarce natural resources, economic efficiency is said to be achieved.
Consumer surplus happens when the price a consumer pays for any goods or services is less than what he is actually prepared to pay. A producer surplus happens when the price which a supplier gets is much higher than what he expected. A consumer surplus is equal to the product of the market price and the quantity purchased. This surplus is reduced as the number of consumers or the number of units being consumed increases. This increasing consumption pushes up the demand and increases the prices, thereby reducing the consumer surplus.
Consumer surplus also declines with increasing surplus. This is called the law of diminishing marginal utility. This means that the first unit of the product enjoys the maximum marginal utility, while the second unit will enjoy a slightly lesser marginal utility, and the third one will enjoy even lesser than the second one. So the first unit of consumption enjoys maximum marginal utility while the same declines for the subsequent units of consumption.
You can see this at a restaurant, where the first dish that is served will satiate hunger and the subsequent ones are not necessarily needed. Some manufacturers try and recover their costs in the first few units of consumption itself, so that they are not then affected by falling prices, while others try and recover the cost over all units of consumption at a constant fixed price. As the utility falls, the demand slows down and the demand slope begins to slope downwards.
A producer surplus is what the producers earn on the product beyond their cost of manufacture. It contains an element of profit, but also something more. The economic welfare of a community is called community surplus and at equilibrium, it is represented by the sum total of the consumer surplus and the producer surplus. All economic decisions are geared towards increasing the community surplus.
The concepts of consumer surplus and producer surplus are vital in the world of business and cannot be stressed enough.