Demonstrate graphically and explain verbally why the equilibrium values of price and quantity in a supply and demand model lead to the maximum combination of consumer and producer surplus.

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The Answer is To demonstrate that the maximum combination of consumer and producer surplus occurs at the equilibrium of the supply and demand model, we show that a point away from the free market equilibrium results in less surplus than does the equilibrium point. This is illustrated in the diagram below. Compare point A to the equilibrium point E. At point A price is above the equilibrium price (PA > PE) and quantity is below the equilibrium quantity (QA < QE). The difference between QA and QE represents a loss of trades that would have benefited consumers and producers. This creates a loss of surplus (when compared to the surplus of point E) equal to the shaded triangle.

To demonstrate that the maximum combination of consumer and producer surplus occurs at the equilibrium of the supply and demand model, we show that a point away from the free market equilibrium results in less surplus than does the equilibrium point. This is illustrated in the diagram below. Compare point A to the equilibrium point E. At point A price is above the equilibrium price (PA > PE) and quantity is below the equilibrium quantity (QA < QE). The difference between QA and QE represents a loss of trades that would have benefited consumers and producers. This creates a loss of surplus (when compared to the surplus of point E) equal to the shaded triangle.

Demonstrate Graphically and Explain Verbally Why the Equilibrium Values of Price