What Is Consumer Surplus?
Consumer surplus is an economic measurement of consumer benefits resulting from market competition. A consumer surplus happens when the price that consumers pay for a product or service is less than the price they're willing to pay. It's a measure of the additional benefit that consumers receive because they're paying less for something than what they were willing to pay.
Consumer surplus may be compared with producer surplus.
- A consumer surplus happens when the price consumers pay for a product or service is less than the price they're willing to pay.
- Consumer surplus is based on the economic theory of marginal utility, which is the additional satisfaction a consumer gains from one more unit of a good or service.
- Consumer surplus always increases as the price of a good falls and decreases as the price of a good rises.
- It is depicted visually by economists as the triangular area under the demand curve between the market price and what consumers would be willing to pay.
- Consumer surplus plus producer surplus equals the total economic surplus.
Understanding 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 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 gains from one more unit of a good or service. The utility a good or service provides varies from individual to individual based on their personal preference.
Typically, the more of a good or service that consumers have, the less they're willing to spend for more of it, due to the diminishing 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 market price.
Many producers are influenced by consumer surplus when they set their prices.
The Formula for Consumer Surplus
Economists define consumer surplus with the following equation:
Consumer surplus = (½) x Qd x ΔP
- Qd = the quantity at equilibrium where supply and demand are equal
- ΔP = Pmax – Pd, or the price at equilibrium where supply and demand are equal
- Pmax = the price a consumer is willing to pay
Measuring Consumer Surplus
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 the price drawn on the y-axis of the graph and the 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. 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 were sold at 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.
Economic welfare is also called community surplus, or the total of consumer and producer surplus.
Example of Consumer Surplus
Consumer surplus is the benefit or good feeling of getting a good deal. For example, let's say that you bought an airline ticket for a flight to Disney World during school vacation week for $100, but you were expecting and willing to pay $300 for one ticket. The $200 represents your consumer surplus.
However, businesses 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 as the calendar draws near to school vacation week raises its ticket prices to $300 each.
The airline knows there will be a spike in demand for travel to Disney World during school vacation week and that consumers will be willing to pay higher prices. So by raising the ticket prices, the airlines are taking consumer surplus and turning it into producer surplus or additional profits.
Is a High Consumer Surplus Good?
A high consumer surplus means that goods are priced quite a bit lower in the market than where consumers would ultimately be willing to pay. This is often the result of a high degree of competition, technological progress, and producer efficiency. In general, all of these things are considered to be "good" for promoting economic growth and prosperity.
What Is Producer Surplus?
Similar to consumer surplus, producer surplus is the economic benefit to producers of goods measured by the difference in market price and where the producer would be willing to sell. A producer surplus thus exists if the market price of a good is higher than the price the producer is willing to sell.
What Is Total Economic Surplus?
Total economic surplus is equal to the producer surplus plus the consumer surplus. It describes the total net benefit to society from free markets in goods or services.
The Bottom Line
In free markets, producers compete with one another to be the low-cost producer and grab market share from other companies in their space. The result is more quantity and lower prices for consumers, often lower than where they would be willing to pay for it. This difference between the market price (as determined by supply and demand) and the willingness to pay is the consumer surplus. A consumer surplus is seen as a benefit to the economy.