3.9. Consumer Surplus—Value minus Expenditure

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To this point, we have discussed the fundamentals of demand and supply curves and explained a simple model of how a market can be expected to arrive at an equilibrium combination of price and quantity. While it is certainly necessary for the analyst to understand the basic working of the market model, it is also crucial to have a sense of why we might care whether the market tends toward equilibrium. This question moves us into the normative, or evaluative, consideration of whether market equilibrium is desirable in any social sense. In other words, is there some reasonable measure we can apply to the outcome of a competitive market that enables us to say whether that outcome is socially desirable? Economists have developed two related concepts called consumer surplus and producer surplus to address that question. We will begin with consumer surplus, which is a measure of how much net benefit buyers enjoy from the ability to participate in a particular market.

To get an intuitive feel for this concept, consider the last thing you purchased. Maybe it was a cup of coffee, a new pair of shoes, or a new car. Whatever it was, think of how much you actually paid for it. Now contrast that price with the maximum amount you would have been willing to pay for it instead of going without it altogether. If those two numbers are different, we say you received some consumer surplus from your purchase. You received a “bargain” because you were willing to pay more than you had to pay.

Earlier we referred to the law of demand, which says that as price falls, consumers are willing to buy more of the good. This observation translates into a negatively sloped demand curve. Alternatively, we could say that the highest price that consumers are willing to pay for an additional unit declines as they consume more and more of it. In this way, we can interpret their willingness to pay as a measure of how much they value each additional unit of the good. This point is very important: To purchase a unit of some good, consumers must give up something else they value. So the price they are willing to pay for an additional unit of a good is a measure of how much they value that unit, in terms of the other goods they must sacrifice to consume it.

If demand curves are negatively sloped, it must be because the value of each additional unit of the good falls the more of it they consume. We will explore this concept further later, but for now it is enough to recognize that the demand curve can thus be considered a marginal value curve because it shows the highest price consumers are willing to pay for each additional unit. In effect, the demand curve is the willingness of consumers to pay for each additional unit.

This interpretation of the demand curve allows us to measure the total value of consuming any given quantity of a good: It is the sum of all the marginal values of each unit consumed, up to and including the last unit. Graphically, this measure translates into the area under the consumer’s demand curve, up to and including the last unit consumed, as shown in Exhibit 12, in which the consumer is choosing to buy Q1 units of the good at a price of P1. The marginal value of the Qth1 unit is clearly P1, because that is the highest price the consumer is willing to pay for that unit. Importantly, however, the marginal value of each unit up to the Qth1 is greater than P1.7

Because the consumer would have been willing to pay more for each of those units than she actually paid (P1), then we can say she received more value than the cost to her of buying them. This concept is referred to as consumer surplus, and it is defined as the difference between the value that the consumer places on those units and the amount of money that was required to pay for them. The total value of Q1 is thus the area of the vertically crosshatched trapezoid in Exhibit 12. The total expenditure is only the area of the rectangle with height P1 and base Q1. The total consumer surplus received from buying Q1 units at a level price of P1 per unit is the difference between the area under the demand curve, on the one hand, and the area of the rectangle, P1 × Q1, on the other hand. That area is shown as the lightly shaded triangle.

Exhibit 12. Consumer Surplus


Calculating Consumer Surplus

A market demand function is given by the equation Qd = 180 – 2P. Determine the value of consumer surplus if price is equal to 65.


First, insert 65 into the demand function to find the quantity demanded at that price: Qd = 180 – 2 (65) = 50. Then, to make drawing the demand curve easier, invert the demand function by solving it for P in terms of Q: P = 90 – 0.5Q. Note that the price intercept is 90, and the quantity intercept is 180. Draw the demand curve:

Find the area of the triangle above the price and below the demand curve, up to quantity 50: Area of a triangle is given as 1/2 Base × Height = (1/2)(50)(25) = 625.


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