Consumer Surplus

Consumer Surplus is the difference between the price that consumers pay and the price
that they are willing to pay. On a supply and demand curve, it is the area between the equilibrium
price and the demand curve.
Consumer surplus is the area under the demand curve (see the graph below) that
represents the difference between what a consumer is willing and able to pay for a product, and
what the consumer actually ends up paying. Consumer surplus is positive when the price the
consumer is willing to pay is more than the market price.

How to Calculate Consumer Surplus

In this graph, the consumer surplus is equal to 1/2 base x height.
The market price is $18 with quantity demanded at 20 units (what the consumer actually
ends up paying), while $30 is the maximum price someone is willing to pay for a single unit. The
base is $20.
1/2 x (20) x [(30 – 18)] = $120
Consumer Surplus Formula
In a graph like the one shown above, the formula for calculating consumer surplus is 1/2
the length of the base multiplied by the overall height.
In addition, the more general formula for calculating surplus formula outside the context
of the graph is as follows:
Consumer surplus = maximum price willing to pay – actual price
 In other words, this formula for consumer surplus represents the difference between the
highest amount the consumer would pay (“maximum price willing to pay”) and the actual
amount that the consumer pays (“actual price”).
Example of Consumer Surplus
Let’s apply the above formula to an example situation. Let’s say there is a consumer who
is in search of a car that fits a particular set of specifications: mileage of less than 50,000 miles
and heated leather seats. The maximum price that this consumer would be willing to pay for a car
that meets these criteria is $8,000. But lucky for them, they find a car that has only been driven
30,000 miles and has comfortable heated leather seats, and it’s being sold for only $6,000! Let’s
plug that into the above formula:
Consumer surplus = $8,000 – $6,000
That means in this case the consumer surplus is a total of $2,000. This leftover money
that the consumer was willing to pay for their car can now be applied to other purchases.
Consumer surplus and economic welfare
Consumer surplus is a measure of the welfare that people gain from consuming goods
and services
Consumer surplus is defined as the difference between the total amount that consumers
are willing and able to pay for a good or service (indicated by the demand curve) and the total
amount that they actually do pay (i.e. the market price).
Consumer surplus is shown by the area under the demand curve and above the price.

Consumer surplus and price elasticity of demand

How is consumer surplus affected by the elasticity of a demand curve?
 When the demand for a good or service is perfectly elastic, consumer surplus is zero
because the price that people pay matches exactly what they are willing to pay.
In contrast, when demand is perfectly inelastic, consumer surplus is infinite. In this
situation, demand does not respond to a price change. Whatever the price, the quantity demanded
remains the same. Are there any examples of products that have such zero price elasticity of
demand? Perhaps the closest we get is a life-saving product with no obvious substitutes - in this
situation, consumers' willingness to pay will be extremely high
The majority of demand curves in markets are assumed to be downward sloping. When
demand is inelastic (i.e. Ped<1), there is a greater potential consumer surplus because there are
some buyers willing to pay a high price to continue consuming the product. Businesses often
raise prices when demand is inelastic so that they can turn consumer surplus into producer
surplus!
Consumer surplus with elastic and inelastic demand curves

When there is a shift in the demand curve leading to a change in the equilibrium market
price and quantity, then the level of consumer surplus will change too
What is the significance of consumer surplus?
In competitive markets, firms have to keep prices relatively low, enabling consumers to
gain consumer surplus. If markets were not competitive, the consumer surplus would be less and
there would be greater inequality.
A lower consumer surplus leads to higher producer surplus and greater inequality.
Consumer surplus enables consumers to purchase a wider choice of goods
Can firms reduce consumer surplus?
Firms can reduce consumer surplus if they have market power. – This enables them to
raise prices above the competitive equilibrium.
In a monopoly, a firm will maximise profits by reducing consumer surplus. See
monopoly diagram
Another way to reduce consumer surplus is to engage in price discrimination.
Charging different prices to different groups of consumers. Those with inelastic demand
will see their consumer surplus reduced. More on Price discrimination. To completely eliminate
consumer surplus, a firm would need to engage in first-degree price discrimination – this means
charging the consumer the highest price they are willing to pay.
To gain market power, a firm could advertise to create brand loyalty, this will make
demand more inelastic
Demand Function

A demand function is a mathematical equation which expresses the demand of a product

or service as a function of the its price and other factors such as the prices of the substitutes and
complementary goods, income, etc.

It can be express as an equation:

Qd=f(P)

A demand functions creates a relationship between the demand (in quantities) of a product (which
is a dependent variable) and factors that affect the demand such as the price of the product, the
price of substitute and complementary goods, average income, etc., (which are the independent
variables).

Another equation of showing demand function is :

Qd=a – Bp

Wherein:

Qd= quantity demanded

P= price

a= intercept (number of Qd if the price is Pxx)

b= slope= Qd

Example from Demand Schedule

Price per piece of Candy Quantity Demanded

Php 5 10
4 20
3 30
2 40
 1 50
0 60

Qd= 60-10P

If P=1 Qd=? If P=5 Qd=?

Qd=60=10P Qd=60 – 10P

Qd= 60- 10(5) Qd= 60- 10(1)

Qd= 60-50 Qd= 60-10

Qd= 10 pieces Qd= 50 pieces

Types of Demand Function

Based on whether the demand function is in relation to an individual consumer or to all

consumers in the market, the demand function cab be categorized as, Individual Demand
Function
and Market Demand Function.

Individual Demand Function

Individual demand function refers to the functional relationship between demand made
by an individual consumer and the factors affecting the individual demand. It shows how
demand made by an individual in the market is related to its determinants.

Mathematically, individual demand function can be expressed as,

Dx= f (Px, Pr, Y, T, F)

Where,
Dx= Demand for commodity x;

Px= Price of the given commodity x;

Pr= Price of related goods;

Y= Income of the individual consumer;

T= Tastes and preferences;

F= Expectation of change in price in the future.

Market Demand Function

Market demand function refers to the functional relationship between market demand and
the factors affecting market demand. Market demand is affected by all the factors that affect an
individual demand. In addition to this, it is also affected by size and composition of population,
season and weather conditions, and distribution of income.
Mathematically, market demand function can be expressed as,

Dx= f (Px, Pr, Y, T, F, Po, S, D)

Where,

Dx= Demand for commodity x;

Px= Price of the given commodity x;

Pr= Price of related goods;

Y= Income of the individual consumer;

T= Tastes and preferences;

F= Expectation of change in price in the future;

Po= Size and composition of population;

S= Season and weather;

D= Distribution of income.
Aguilar,Irrah S.
BSA 1-1