What is consumer surplus?
Consumer surplus is an economic measure of consumer benefits. Consumer surplus occurs when the price consumers pay for a product or service is less than the price they are willing to pay. It is a measure of the additional benefit consumers receive because they pay less for something than they were willing to pay.
Key points to remember
- Consumer surplus occurs when the price consumers pay for a product or service is less than the price they are willing to pay.
- Consumer surplus is based on the economic theory of marginal utility, which is the extra satisfaction a consumer gets from an extra unit of a good or service.
- Consumer surplus always increases when the price of a good falls and decreases when the price of a good rises.
Understanding Consumer Surplus
The concept of consumer surplus was developed in 1844 to measure the social benefits of public goods such as national roads, canals and bridges. It has been an important tool in the field of welfare economics and the formulation of tax policies by governments.
Consumer surplus is based on the economic theory of marginal utility, which is the additional satisfaction a consumer derives from an additional unit of a good or service. The usefulness of a good or service varies from one individual to another depending on their personal preferences.
Generally, the more consumers own a good or service, the less they are willing to spend more on it, due to the diminished marginal utility or additional benefit they receive. A consumer surplus occurs when the consumer is willing to pay more for a given product than the current price. market price.
Many producers are influenced by consumer surplus when setting their prices.
Measuring consumer surplus
The demand curve is a graphical representation used to calculate consumer surplus. It shows the relationship between the price of a product and the quantity of the product demanded at that price, with the price plotted on the y-axis of the chart and the quantity requested drawn on the abscissa axis. Due to the law of diminishing marginal utility, the demand curve has a downward slope.
Consumer surplus is measured as the area below the sloping demand curve, or the amount a consumer is willing to spend on given quantities of a good, and above the true market price of the good, represented by a horizontal line between the y-axis and the demand curve. Consumer surplus can be calculated on an individual or aggregate basis, depending on whether the demand curve is individual or aggregate.
Economic welfare is also referred to as community surplus, or the total of consumer and producer surplus.
Consumer surplus always increases when the price of a good falls and decreases when the price of a good rises. For example, suppose consumers are willing to pay $50 for the first unit of product A and $20 for the 50th unit. If 50 of the units are sold at $20 each, then 49 of the units have been sold to a consumer surplus, assuming the demand curve is constant.
Consumer surplus is zero when the demand for a good is perfectly elastic. But demand is perfectly inelastic when consumer surplus is infinite.
Example of consumer surplus
Consumer surplus is the benefit or pleasant feeling of getting a bargain. For example, suppose you purchased an airline ticket for a flight to Disney World during the school vacation week for $100, but expected to pay $300 for a ticket. The $200 is your consumer surplus.
Yet companies know how to turn consumer surplus into producer surplus or for their gain. In our example, let’s say the airline realizes your surplus and the schedule is approaching the school vacation week to increase the price of its tickets to $300 each.
The airline knows there will be an increase in demand for trips to Disney World during the school vacation week and that consumers will be willing to pay higher prices. Thus, by raising ticket prices, airlines take consumer surplus and turn it into producer surplus or additional profits.