Consumer surplus

Consumer surplus is an economic concept that shows the difference between the amount of money a consumer is willing to spend on a particular good and the amount of money the consumer actually spends on it. Consumer surplus is a type of economic surplus. Economists study consumer surplus to understand prices and to better understand the health of the economy. Consumer surplus can be measured using a demand curve.

Background

The study of economics is the study of how societies use and distribute scarce resources. Economic concepts are supposed to help people better understand how consumers, producers, and markets act. The consumer surplus is one of the fundamental concepts in economics. Economists measure the consumer surplus using graphs and mathematical calculations. Economists find the consumer surplus for a number of reasons. Finding the consumer surplus can help economists and businesses understand how to price goods. Economists also study economic surplus because it helps them judge economic welfare, which is the level of prosperity or economic success of a particular area or group.

Overview

Consumer surplus is the difference between the amount of money a consumer is willing to spend on an item and the actual amount of money a consumer spends. For example, a consumer may be willing to pay $10 for a particular toy. The toy is on sale for $8. The difference between those two amounts, $2, is the consumer surplus.

The consumer surplus can be shown using a demand curve. A demand curve is a graph that shows that demand for a good or service increases as the price decreases. Similarly, the demand for a good decreases as the price increases. The y-axis of the graph shows the price of each good. The x-axis of the graph shows the supply of the good at each price. Since the demand increases as price decreases, demand curves (for the most part) slope downward and to the right. They move downward because price decreases. They move to the right because the number of people demanding a good increases as the price decreases.

The highest price a consumer is willing to pay for a particular good is called the reservation price. If a particular good is priced above the reservation price, no consumers will buy it. So, the demand curve begins at the reservation price because that is the price at which consumers first demand the good or service. At the reservation price, some consumers will buy the good. As the price decreases, the number of consumers willing to buy the product increases. As the price decreases, however, the number of producers willing to create the good decreases because each producer will make less profit on the goods that are sold.

Most producers will not sell their goods at the reservation price. Even though the reservation price is the highest price people will pay for a good, most producers sell below the reservation price because very few consumers will pay that price. Instead, producers generally look for a spot on the demand curve called the equilibrium price. This is the point at which the demand curve intersects with the supply curve. The supply curve slopes upward and toward the right. The supply curve shows the number of producers willing to supply the good. As the number of consumers willing to buy a product increases, the number of producers willing to supply the good also increases. So, as the line moves to the right, it also slopes upward.

On the graph, the supply curve will intersect with the demand curve at a point called equilibrium. This point is meant to show the best possible price for a particular good or service. This price point (from the y-axis) is the one at which the most consumers are willing to buy, and the most producers are willing to supply the good or service. For example, ABC Company sells bikes. The prices $100, $90, $80, $70, $60, and $50 are listed on the chart. More people will buy the bike for $50 than will buy the bike for $100, so the demand curve plotted on the chart will slope downward. The supply curve can be plotted on the same graph. The supply curve shows the number of producers willing to make a particular product. The supply curve will curve upward.

When the two curves are plotted, they meet at $75. That point is the equilibrium price. ABC Company sells its bikes for $75. ABC Company will cause consumer surplus because of its pricing decision. Since the reservation price is $100, it is clear that some people would pay $100 for the bike. However, more people will purchase the bike for $75, so ABC Company will accept that they will cause some consumer surplus. ABC Company can compute how much total consumer surplus the $75 price will cause. Consumer surplus can be measured by drawing a horizontal line on the graph. The line should be drawn from the current price on the demand curve—in this case, from the $75 point on the demand curve. The line should be drawn from that point to the y-axis. The line creates a triangle on the graph. ABC Company can calculate the area of the triangle (area of triangle = 1/2 base x height) to find the exact consumer surplus on the graph.

A consumer surplus means that the consumer spent less money than they were willing and able to pay, even though the consumer does not actually have more money than before a good was purchased. That means that the consumer might use that money to pay for other things. Economists recognize that consumers and producers might spend their economic surpluses in different ways. Common ways people spend economic surpluses include private consumption, cultural experiences, leisure, investment, and research and development.

Some producers see consumer surplus as lost revenue. Producers will try to find out how to decrease the amount of consumer surplus on the goods they sell. Nevertheless, in a market without any controls (e.g., price floors or price limits), consumer surplus and producer surplus will occur. Some people are willing to pay more for products than other people, and some producers are willing to sell items for less money than other producers. In unregulated markets, though, most items are usually sold near equilibrium, where little consumer surplus and little producer surplus occurs.

Bibliography

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