Question

Draw a typical supply and demand diagram. Show what happens when the preference for the product declines, causing the demand to decline. What is the effect on consumer surplus? What is the effect on producer surplus? What happens to total surplus? Is total surplus maximized? Explain.

Answer 1

When preference for a product declines, the demand decreases. This leads to a decrease in consumer and producer surplus, as well as a reduction in total surplus. Total surplus is not maximized when demand declines.

Step-by-step explanation:

When the preference for a product declines, it leads to a decrease in demand. This can be shown on a typical supply and demand diagram by shifting the demand curve to the left. The new equilibrium price and quantity will be lower than the original equilibrium.

When the demand declines, it has the following effects:

1. Effect on consumer surplus: Consumer surplus, which represents the difference between the price consumers are willing to pay and the actual price, decreases. As the demand decreases, consumers are willing to pay less for the product, resulting in a smaller consumer surplus.
2. Effect on producer surplus: Producer surplus, which represents the difference between the price producers receive and the actual cost of production, also decreases. With a decline in demand, producers are likely to receive lower prices for their products, reducing their producer surplus.
3. Effect on total surplus: Total surplus, which is the sum of consumer surplus and producer surplus, decreases when demand declines. This is because both consumer and producer surpluses decrease with a decline in demand.
4. Is total surplus maximized: No, total surplus is not maximized when demand declines. Total surplus is maximized when the economy is getting as much benefit as possible from its scarce resources, which occurs at the equilibrium point where supply and demand intersect.