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French engineer and economist Arsene Jules Dupit (1804 – 1866) introduced the law of consumer’s surplus in 1844.
He used this concept to measure the social benefit.
Later, Alfred Marshall rediscovered and refined the theory of consumer surplus in his book Principles of Economics, published in 1890.
A consumer gets surplus when the price he/she actually pays is lower than the price he expects or is willing to pay.
The consumer surplus is a difference between the price willing to pay and the price actually paid in the market while buying the goods and services.
In other words, people generally get more satisfaction or utility from the consumption of goods than the actual price they pay for them.
That extra satisfaction obtained by the consumers from buying goods has been called consumer’s surplus.
According to A. Koutsoyannis, “Consumer’s surplus is equal to the difference between the amount of money that consumer actually pays to buy a certain quantity rather than go without it.”
Consumer surplus results when a consumer derives more benefit (in terms of monetary value) from a good or service than the price he/she pays to consume it.
Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Currency of your country
Imagine you are going to a Mobile Shop to buy a new midrange mobile phone set.
Before you go to the store, you decide to yourself that you are not going to pay more than Rs 16,000 (₹ 10,000 or $135) for a mobile phone set.
This Rs 16,000 is your maximum willingness to pay for the mobile set.
After entering the store, you find a mobile set you really like for only Rs 14,400 (₹ 9,000 or $122).
Since you were willing to pay Rs 16,000 for the mobile set; but, you only ended to pay Rs 14,400 for it.
You have saved Rs 1,600 i.e. 16,000 – 14,400.
This Rs 1,600 is called consumer surplus by economists, because it is the “extra” or “surplus” value you received from the good beyond the price you paid for it.
In short the consumer’s surplus (CS) is a difference between the price actually does pay and willing to pay.
Consumer’s surplus (CS) = WP – AP
Where,
WP = willing to pay price
AP = actually paid price
It is also expressed as:
Consumer’s surplus (CS) = TU – TS
Where,
TU = total utility or total benefit derived
TS = total amount spent
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1. Expected price should be more than actual price
2. Marginal utility must be greater or equal to the price of commodity
3. Utility can be measured by utils
Here, Amount = Rs = $ = £ = € = ₹ = Af = ৳ = Nu = Rf = රු = Currency of your country
The concept of consumer surplus for an individual consumer is represented in table.
Units of goods |
Price ($/₹/Rs) willing to pay |
Actual price ($/₹/Rs) |
Consumer surplus |
1 |
120 |
60 |
60 |
2 |
100 |
60 |
40 |
3 |
80 |
60 |
20 |
4 |
70 |
60 |
10 |
5 |
60 |
60 |
0 |
Total |
430 |
300 |
130 |
In the table, a consumer is ready to pay Rs 120 for the first unit of the goods.
One actually does pay only Rs 60.
Now she/he has surplus Rs 60.
In the same way, the consumer is ready to pay Rs 100, Rs 80, Rs 70 and Rs 60 for second, third, fourth and fifth unit respectively.
But actually he pays only Rs 60, Rs 40, Rs 20, Rs 10 and Re 0 respectively.
Therefore, the consumer surplus
= 430 – 300
= 130
Instead of figuring out an individual’s surplus, let us figure out the total amount of surplus for all consumers in the market and derive the total consumer surplus.
An easy way to understand, it is shown in figure:
Suppose in this mini market we have 5 consumers and we line them up left to right by their willingness to pay (consumer 1 is willing to pay more than consumer 2 etc).
You can see that each consumer pays the same price (the market price is $5) for the good, so their surplus is calculated as the difference between their willingness to pay and the actual amount they have to pay.
For the first consumer, he is willing to pay $20, but only has to pay $5, so he gets a surplus of $15 (20 – 5).
The next consumer is willing to pay $16, but only has to pay $5, so he gets a surplus of $1 (16 – 5).
Using the same logic, the third, fourth and fifth consumers have surplus values equal to $5, $3 and $0 (because the maximum willingness to pay off the fifth consumer is equal to the price, so consumer surplus is zero.)
To get total surplus we add these values up, so $15 + $11 + $5 + $3 = $34.
The total consumer surplus in this market is $34.
But in reality, most graphs will not look like this.
So, let us do another example.
For this, let us consider following figure:
In the above figure, we have denoted price and marginal utility (in terms of price) on the Y-axis and quantity of goods on the X-axis.
In figure, you will see a typical linear demand curve denoted PWD with a price line intersecting it at point E (which gives us equilibrium price and quantity).
Because point E is at equilibrium, QA is the quantity of goods that will be purchased from the market and consumers will pay a price of PA.
We will use the information to calculate consumer surplus for this graph.
Remember that consumer surplus is equal to the difference between a consumer’s maximum willingness to pay (PW) and the price that they do have to pay (PA) actually.
Since the demand curve is above the price at points to the left of QA, each of these purchases results in surplus.
When PA intersects the demand curve, there is no surplus and to the right of QA consumers are not willing to pay the price.
So, in the graphical example, we would have to calculate the area of a triangle which is equal to ½(base × height).
In our example, the base is equal to OQA (PAE) and the height is equal to PAPW (maximum willingness to pay price OPW minus actual price paid PA).
This gives us consumer’s surplus equal to ½[(PW – PA) × QA]
Whenever you are asked to calculate consumer surplus, remember to insert/put the numbers given to you in this formula.
You should be able to figure out what the PW is (where demand intersects the Y axis) and PA and QA.
With this information, you just have to calculate the area of the triangle and you know what consumer surplus will be.
In terms of figure, consumers are willing to make payment equal to the area OPW EQA to purchase the amount of goods equal to OQA.
The maximum willingness to pay price (PW) is OPW but actually the market price is only OPA.
As the willingness to pay price is higher than the price that the consumer have to pay, there is consumer surplus.
Consumer surplus is equal to the shaded area of triangle PWEPA.
Thus, in graphical term area underneath the demand curve but above the price line is equal to consumer surplus.
This law of consumer surplus is criticized by the several economists including Nicholas Kaldor, J.R. Hicks and P.A. Samuelson on the several grounds:
This law assume that the marginal utility of money be constant out in practical life when the quantity of money be increase marginal utility of money be decreases.
Similarly, when the quantity money decreases, the marginal utility of money increases.
In the same way, when the income is increased, it decreases the marginal utility of money.
This law is only the imaginary law; because in real life nobody will be ready to pay more prices to the commodity than the actual price.
The law of consumer surplus is based on the assumption that utility can be measured quantitatively in the term of money.
But, utility is subjective phenomenon, it cannot be measure quantitatively.
Consumer surplus is not applicable to the necessaries and luxurious goods.
A consumer is simply willing to acquire goods.
The consumer does not show any interest to get surplus.
Consumer’s surplus neglects the complementary and substitutable goods.
The utility of any commodity is depends on others commodity.
But, this theory does not explain the role of complementary goods and substitution goods.
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Consumer surplus has the following significance or importance in economic analysis:
This law is very useful to determine the price of goods and services.
If the surplus is very high, the producer can determine high price of goods and services and vice versa.
The law of consumer surplus is useful to government to determine tax rate.
The government can determine high rate of tax which goods and services have more consumer surplus and vice versa.
This law of consumer’ surplus can be guidelines for both consumer and producer.
It can help to the consumer to maximize the surplus similarly it helps to the producer to maximize the profit.
The law of consumer surplus helps in cost benefit analysis as well as in project selection.
If the expected cost incurred in production the project may be selected on the other hand the consumer fell that they are not getting any surplus, the project may not be selected.
The law of consumer surplus is significant to estimate the gain from the international trade.
The Government can produce that types of goods and service which have more consumer’s surplus.
The law of consumer surplus helps us to distinguish between value in use and value of exchange.
Value in use means utility and value in exchange means price of commodity.
Commodities like salt, match box, medicine etc has a great value in use but very small value in exchange.
Consumer surplus from such commodities is very large because we are ready to pay much more for such commodities than we actual pay.
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