What is 'Consumer Surplus'
Consumer surplus is an economic measure of consumer benefit, which is calculated by analyzing the difference between what consumers are willing and able to pay for a good or service relative to its market price, or what they actually do spend on the good or service. A consumer surplus occurs when the consumer is willing to pay more for a given product than the current market price.
BREAKING DOWN 'Consumer Surplus'
The concept of consumer surplus was developed in 1844 to measure the social benefits of public goods such as national highways, canals and bridges. It has been an important tool in the field of welfare economics and in the formulation of tax policies by governments.
Consumer surplus is based on the economic theory of marginal utility, which states the price an individual is willing to spend on a particular good or service reflects the amount of utility he receives from that good or service. The utility a good or service provides varies from individual to individual based on his own personal preference. Economic law holds that the more a consumer has of a good the less he is willing to spend for more due to the diminishing marginal utility he receives.
Measuring Consumer Surplus With a Demand Curve
The demand curve is a graphic 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 price drawn on the y-axis of the graph and quantity demanded drawn on the x-axis. Because of the law of diminishing marginal utility, the demand curve is downward sloping.
Consumer surplus is measured as the area below the downward-sloping demand curve, or the amount a consumer is willing to spend for given quantities of a good, and above the actual market price of the good, depicted with a horizontal line drawn between the y-axis and demand curve. Consumer surplus can be calculated on either an individual or aggregate basis, depending on if the demand curve is individual or aggregated. Consumer surplus always increases as the price of a good falls and decreases as the price of a good rises.
To illustrate, suppose an individual or economy is 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 were sold at a consumer surplus, assuming the demand curve is constant. Consumer surplus is depicted as the triangle that forms between the following points on a graph: (0,50), (0,20) and (50,20). The numerical value is calculated as half, or 0.50, multiplied by the base of the triangle multiplied by the height of the triangle, or 0.50*30*50.