Understanding Consumer Surplus
Consumer Surplus or Buyer’s Surplus is an economic measurement of the customer’s excess benefit. In an economy, a consumer surplus takes place when the consumer is willing to pay more for a product than its market price. Consumer Surplus is an important study in the subject of Economics. Here, we are going to provide insights on “What is Consumer Surplus?”, the method of calculating the surplus, and other important elements of the topic will be discussed.
What is Consumer Surplus?
Consumers' surplus is a tool for measuring the consumer’s welfare and this surplus is defined as the excess of the social valuation of a product that goes over the price that is being actually paid.
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In the above diagram, graphically, consumer surplus is being measured by the area of a triangle that gets formed below a demand curve (shaded in red color) and above the market price (P1).
Further, we will talk about it in detail in the Consumer Surplus formula.
Consumer Surplus and Producer Surplus
While we discuss the consumer and producer surplus, it is very much important that we also understand some basic concepts that are used by economists to explain the interrelationship between the two.
Both the consumers and producer surplus can be graphically illustrated by either the demand curve or the marginal benefit curve and a supply curve or the marginal cost curve.
So, consumer surplus refers to the monetary gain that is enjoyed when a purchaser buys a product for a lesser value than they normally were willing to pay. On the other hand, producer surplus means the price difference that is there between the lowest cost to supply the market and the actual price which the consumers are willing to pay.
How to Calculate Consumer Surplus?
In order to calculate the consumer surplus, we need to consider the factor of demand and supply. The demand curve is a line of a graph that is utilized in economics, this line shows how many units of a good or service are purchased at different prices. The consumer surplus formula is CS = ½ (base) (height).
Consumer Surplus Graph
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From the above diagram, we will understand Consumer Surplus. In the Price axis, the prices are 70 and 50. In the Quantity axis, the quantity is 40. Demand Curve and Supply are drawn accordingly.
The point where the demand and the supply curve meet are marked as the equilibrium price, that is 50. The area above the supply curve and below the equilibrium price is shaded in blue, in this zone the product surplus (or PS) is achieved. While, the area which lies below the demand curve and above the equilibrium price is shaded in green, this area is called the consumer surplus (or CS).
Thus, taking into consideration the demand and supply curves, the formula for consumer surplus as mentioned previously is Consumer Surplus = ½ (base) (height).
Hence, in our example, CS = ½ (40) (70-50) = 400.
Assumptions of Consumer Surplus
Following are the assumptions of the consumer surplus theory:
The utility is a measured type entity:
The consumer surplus theory explains that the value of utility is to be measured. Under Marshallian economics, utility is expressed as a number. For example, the utility derived from ice cream is 10 units. Thus, this is an assumption that Consumer Surplus consists of this explanation of Utility as well.
No substitutes are available in the explanation:
While understanding the Consumers Surplus there are no available substitutes taken into consideration.
Ceteris Paribus:
This connotes that the customers’ tastes, preferences, and income will not change in any circumstances.
Marginal utility of money remains constant:
This is another assumption which states that the utility that is being derived from the income of a consumer remains constant. There is no change in the amount of money that a consumer possesses, also the amount of utility that they derive from it is not changed. This factor is important as money cannot be used to measure the utility without the assumption.
Law of diminishing marginal utility:
The law of DMU or Diminishing Marginal Utility is also used here, which states that the more a product or service is consumed, the lower be the marginal utility which is derived from consuming each and extra of that same unit.
Independent marginal utility:
The marginal utility which is being derived from the product that is consumed does not get affected by the marginal utility that is actually derived from consuming similar types of goods or services. For example, if you consume a pastry, the utility derived from it will not be affected by the utility which is derived from a muffin.
Importance of Consumer Surplus
As studied, Consumer Surplus is the maximum amount that a consumer is willing to pay for the product minus the price that he actually pays. The consumer surplus thus reflects the amount of utility or the gain which the customers receive when they buy specific products and services from a specific producer. Therefore, consumer surplus is important for the producers who own small businesses, because consumers can derive a large benefit from buying their products and they are more inclined to purchase them again in the future.
Did You Know?
Consumer Surplus was discovered by Jules Dupuit in the year 1884. He was a French civil engineer and an economist. It was later popularized by the British economist Alfred Marshall. The concept was based on the assumption that the degree of satisfaction of consumers (that is utility) can be made measurable.
It is obvious that consumer surplus always increases as the price of a good falls and again it decreases as the price of goods peaks up. Thus, the critics comment about the existence of the consumer surplus. It is all about the play of price, they justify.
Consumer Surplus is used as a tool by the government to formulate tax policies.
By the study of the concept of Consumer Surplus, we are introduced to a good way by which the value of a product or a service is measured. The students are advised to go through this topic and understand the graphs and formulas priorly.
FAQs on What Is Consumer Surplus?
1. What is consumer surplus in economics?
Consumer surplus is an economic measure that represents the benefit consumers receive when they purchase a good or service at a price lower than the maximum price they would have been willing to pay. It’s essentially the extra value a consumer gets from a transaction.
2. How is consumer surplus calculated?
Consumer surplus is typically calculated as the area below the demand curve and above the market price in a supply and demand graph. Graphically, it forms a triangular area where the base is the quantity demanded at the market price, and the height is the difference between the highest price a consumer would pay and the actual market price.
3. What is the key difference between consumer surplus and producer surplus?
The main difference lies in whose benefit is measured. Consumer surplus measures the economic benefit buyers receive by paying less than their maximum willingness. In contrast, producer surplus measures the economic benefit sellers receive by selling at a price higher than their minimum willingness to sell. Both concepts contribute to the overall welfare in a market.
4. Can you provide a real-world example of consumer surplus?
Certainly. Imagine you're looking to buy a new smartphone and are willing to pay up to ₹40,000 for a specific model. However, you find a sale and purchase the phone for ₹35,000. In this scenario, your consumer surplus is ₹5,000 (₹40,000 - ₹35,000), representing the extra value you received because you paid less than your maximum valuation.
5. Why is understanding consumer surplus important in economics?
Understanding consumer surplus is crucial because it helps economists and policymakers assess consumer welfare and market efficiency. It shows the value consumers gain beyond the price they pay, which is a key component of overall economic welfare. It also helps in analyzing the impact of government interventions like taxes or subsidies.
6. How does a change in product price affect consumer surplus?
When the price of a product decreases, consumer surplus typically increases. This happens because existing consumers now pay less, and new consumers who were previously unable to afford the product can now buy it. Conversely, if the price of a product increases, consumer surplus will decrease as consumers either pay more or stop buying the product.
7. What factors, other than price, can influence consumer surplus?
Beyond price, several other factors can influence consumer surplus:
- Consumer preferences and tastes: Stronger desires for a product can increase willingness to pay, potentially increasing surplus.
- Income levels: Changes in consumer income can affect their willingness and ability to pay, thus impacting surplus.
- Availability of substitutes: More readily available or cheaper substitutes can reduce a consumer's willingness to pay a high price, decreasing surplus for a particular good.
- Quality and features: Improvements in product quality or new features at the same price can increase the perceived value and thus the consumer surplus.
8. Is consumer surplus always beneficial, and for whom?
From the consumer's perspective, consumer surplus is always beneficial as it represents the additional satisfaction or value they receive above what they paid. For the economy as a whole, a high consumer surplus generally indicates that resources are being allocated efficiently and that consumers are gaining significant benefits from market transactions. While producers might prefer to capture more of this surplus, it is a positive indicator of market efficiency.
9. How does market equilibrium relate to consumer surplus?
In a perfectly competitive market, consumer surplus is realized at the market equilibrium point, where the supply and demand curves intersect. At this equilibrium price, all consumers who value the good at or above this price will purchase it, and those whose willingness to pay is higher than the equilibrium price will gain a surplus. Equilibrium generally maximizes the total surplus (consumer surplus + producer surplus) in a market.
10. What is the significance of the demand curve in understanding consumer surplus?
The demand curve is essential for understanding consumer surplus because it graphically represents the maximum price consumers are willing to pay for different quantities of a good. The area between this curve and the actual market price line visually demonstrates the consumer surplus, making it a key tool for analyzing consumer benefits in a market.
