Question

1. Define consumer surplus and producer surplus. Explain why the equilibrium price and quantity maximizes the sum of producer plus consumer surplus (the total surplus).

2. There are far more consumers of agricultural commodities than there are producers; but agricultural producers have consistently been able to get Congress to vote them subsidies at taxpayer expense and supply restrictions at the consumer's expense. How can the success of the agricultural lobby be explained by “the general rule of political economy”?

Answer 1

Question 1 When a consumer decides to buy a product, she places a certain value which represents the maximum willingness to pay for that particular good. When all the consumers in the market behave in this way, they have their individual willingness to pay. In the same manner producers when enter the market have a definite willingness to receive for the product they are going to sell.
For consumers it is the maximum willingness to pay and for the producer it is the minimum willingness to receive. Their interaction determines the equilibrium price and the equilibrium quantity of the particular good. This equilibrium price is definitely higher for some individuals so they leave the market, and at the same time, this price is lower for some producers and they also leave the market. Those buyers and sellers that are present in the market therefore enjoy a consumer surplus and producer surplus.
In this sense the consumer surplus for one consumer is the difference in the amount that that particular consumer is willing to pay and what he actually pays. When consumer surplus is added for all the consumers present in the market we get the consumer surplus for the buyers side. Producer surplus is also the difference between what the producers receive as an equilibrium price and the price they were willing to receive. Consumer surplus and producer surplus are definitely maximum when there is no discrepancy in the market related to price or quantity. This implies that there should be no government intervention and there should be no market power to any of the consumer or the producer for the maximization of consumer surplus and producer surplus. If these conditions are ensured then there is no in efficiency in the market and consumer surplus and producer surplus are maximized. This happens because the equilibrium price ensures that marginal buyers and sellers are remained outside the market and price mechanism ensures that there are no distortions with regards to the price or the quantity.

Question 2 This part is not related to only agricultural commodities but to many other commodities because most of the buyers of a particular product are well organised and represent a smaller group where as the consumers represent a very large group which is poorly organized. The organisational structure is important because then, the government cannot be pressurized to take action in their favor. Subsidies are generally provided by the government to ensure that the production of a particular good is not reduced because of increased cost of production. But there are also cases where subsidies are provided to the products which are already earning profits. The the producers of these goods are able to lobby the government because they are well organised. The political economy favours a small group because the advantage to a smaller group is higher than the disadvantage to a larger group when subsidies are provided. Consumers as a group cannot contribute enough to lobby the government in their favor because they are not organised and they have no incentive to pay on their own because they believe that those who are not buying the product should not be paying for others. Producers unite on the other side, and are able to represent a strong yet smaller group. This is the reason why the political economy favors subsidizing the producers than the consumers.