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What is Consumer Surplus?

Consumer surplus, also known as buyer's surplus, is the economic measure of a customer's excess benefit. It is calculated by analyzing the difference between the consumer's willingness to pay for a product and the actual price they pay, also known as the equilibrium price. A surplus occurs when the consumer's willingness to pay for a product is greater than its market price.

Consumer Surplus

Consumer surplus is based on the economic theory of marginal utility, which is the additional satisfaction a person derives by consuming one more unit of a product or service. The satisfaction varies by consumer, due to differences in personal preferences Buyer Types Buyer types is a set of categories that describe spending habits of consumers. Consumer behavior reveals how to appeal to people with different habits . According to the theory, the more of a product a consumer buys, the less willing he/she is to pay more for each additional unit due to the diminishing marginal utility derived from the product.

Calculating Consumer Surplus

Consumer Surplus Chart

The point where the demand and supply meet is the equilibrium price. The area above the supply level and below the equilibrium price is called product surplus (PS), and the area below the demand level and above the equilibrium price is the consumer surplus (CS).

While taking into consideration the demand and supply curves Demand Curve The demand curve is a line graph utilized in economics, that shows how many units of a good or service will be purchased at various prices , the formula for consumer surplus is CS = ½ (base) (height). In our example, CS = ½ (40) (70-50) = 400.

Consumer Surplus and the Price Elasticity of Demand

Consumer surplus for a product is zero when the demand for the product is perfectly elastic. This is because consumers are willing to match the price of the product. When demand is perfectly inelastic, consumer surplus is infinite because a change in the price of the product does not affect its demand. This includes products that are basic necessities such as milk, water, etc.

Demand curves are usually downward sloping because the demand for a product is usually affected by its price. With inelastic demand Inelastic Demand Inelastic demand is when the buyer's demand does not change as much as the price changes. When price increases by 20% and demand decreases by , consumer surplus is high because the demand is not affected by a change in the price, and consumers are willing to pay more for a product.

In such an instance, sellers will increase their prices to convert the consumer surplus to a producer surplus. Alternatively, with elastic demand, a small change in price will result in a large change in demand. It will result in a low consumer surplus as customers are no longer willing to buy as much of the product or service with a change in price.

Law of Diminishing Marginal Utility

According to economist Alfred Marshall, the more you consume a certain commodity, the lower the satisfaction derived from each additional unit of consumption. For example, if you buy one apple for $0.50, you are not willing to pay more for the second apple. At the same time, the utility derived from consuming the second apple is lower than it was for the first apple. The concept is described in the table below:

According to Alfred Marshal: Consumer Surplus = Total Utility – (Price x Quantity)

Law of Diminishing Marginal Utility - Table

Assumptions of the Consumer Surplus Theory

1. Utility is a measurable entity

The consumer surplus theory suggests that the value of utility can be measured. Under Marshallian economics, utility can be expressed as a number. For example, the utility derived from an apple is 15 units.

2. No substitutes available

There are no available substitutes for any commodity under consideration.

3. Ceteris Paribus

It states that customers' tastes, preferences, and income Remuneration Remuneration is any type of compensation or payment that an individual or employee receives as payment for their services or the work that they do for an organization or company. It includes whatever base salary an employee receives, along with other types of payment that accrue during the course of their work, which do not change.

4. Marginal utility of money remains constant

It states that the utility derived from the income of a consumer is constant. That is, any change in the amount of money a consumer has does not change the amount of utility they derive from it. It is required because without it, money cannot be used to measure utility.

5. Law of diminishing marginal utility

It states that the more a product or service is consumed, the lower the marginal utility is derived from consuming each extra unit.

6. Independent marginal utility

The marginal utility derived from the product being consumed is not affected by the marginal utility derived from consuming similar goods or services. For example, if you consumed orange juice, the utility derived from it is not affected by the utility derived from apple juice.

Conclusion

Consumer surplus is a good way to measure the value of a product or service and is an important tool used by governments in the Marshallian System of Welfare Economics to formulate tax policies. It can be used to compare the benefits of two commodities and is often used by monopolies when deciding the price to charge for its product.

Additional Resources

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