CONSUMER

SURPLUS
BY: Atharva Bhange
ROLL NO: 4014
CLASS: FY BCOM DIV: A
 TABLE OF CONTENTS

Introduction - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -
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Meaning - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -
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Explaination and Assumptions - - - - - - - - - - - - - - - - - - - - - - - - - - - -
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Diagrammatic Representation - - - - - - - - - - - - - - - - - - - - - - - - - - - -
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Can consumer surplus be measured? - - - - - - - - - - - - - - - - - - - -
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Importance of consumer surplus - - - - - - - - - - - - - - - - - - - - - - - - - - -
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Criticism of consumer surplus - - - - - - - - - - - - - - - - - - - - - - - - - - - - -
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Example - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -
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Key Takeaways - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -
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INTRODUCTION
CONSUMER SURPLUS
• It was first developed by Jules Dupuit, French civil engineer and economist, in 1844 and
popularized by British economist Alfred Marshall,
• According to this concept consumer satisfaction (utility) is measurable.
• 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.
• The concept of consumer surplus is derived from the law of diminishing marginal utility.
• As per the law, as we purchase/consume more of a commodity, its marginal utility
reduces.
• Since the price is fixed, for all units of the goods we purchase, we get extra utility. This
extra utility is consumer surplus.

MEANING OF CONSUMER
SURPLUS

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 Consumer’s surplus is the excess of what we are prepared to pay over what
we actually pay for a commodity. It is the difference between what we are
prepared to pay and what we actually pay. Thus, Consumer’s surplus = what
one is prepared to pay minus what one actually pays.

We can put it in the form of an equation thus:

Consumer’s Surplus = Total Utility – Total Amount Spent.

Explanation:
We can illustrate the concept of consumer’s surplus with the help of the table
given below:

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It is assumed in the above table that the price of oranges in the market is 50 P. per
orange. The consumer will purchase as many oranges to make his marginal utility
equal to the price. Thus he will purchase 5 oranges and pay for each 50 P. In this
way he will spend in all Rs. 2.50P . But the total utility of the 5 oranges is equal to
690. He thus gets a consumer’s surplus equal to (690 – 250) =440P.

The consumer’s surplus can also be found from the fourth column of the table. The
utility of the first unit of oranges to the consumer is equal to 200 P.; therefore he
would be prepared to pay 200 P. for it rather than go without it. But he pays for the
first orange only 50 p. ,because the price of an orange in the market is 50 p.

Therefore, from the first unit, the consumer gets consumer’s surplus equal to (200
—50) = 150P, which is written in the fourth column. Similarly, the utility of the
second orange is equal to 180 , while the consumer pays 50P. For it and therefore
obtains (180 — 50) = 130P. as consumer’s surplus. From the fifth unit the
consumer derives satisfaction equal to 50 and he also pays 50P for it. Thus there is
no consumer’s surplus from the fifth unit. Now if we add the figures in the 4th
column, we shall get the total consumer’s surplus equal to 440P.

ASSUMPTIONS
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This concept is based on the following assumptions:

Cardinal measurement of utility.

Constant marginal utility of money.

The commodity in question does not have substitutes.

Diagrammatic Representation:

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We can represent consumer surplus with the help of above diagram. Along OX are
measured the units of the Commodity and along OY is measured Marginal utility
in terms of money, which means the price that the consumer is willing to pay,
rather than go without a particular unit of the commodity.

If the market price is PM, the consumer will extend his purchase up to the Mth
unit: That is, he will purchase OM quantity. This is so because for this amount his
marginal utility is equal to the price. But his marginal utility for the earlier units is
more than PM. For M ‘th unit, for instance, his marginal utility is P’M’, but he
only pays the market price PM (= P”M’) for this unit as for others. He thus obtains
an excess of utility for the M ‘th unit equal to P’P”. This is consumer’s surplus
from this unit. Similar surplus arises from the purchase of other units. The total
consumer’s surplus thus derived by him when OM units are purchased at PM Price
is shown by the shaded area UAP. If the market price rises to ‘M’ he will purchase
only OM’ quantity and the consumer’s surplus will fall to the smaller triangle UA ‘
P’.

Can Consumer’s Surplus be Measured?

It looks as if consumer’s surplus can be measured. The measurement of

consumer’s surplus, however, is not as simple as that. There are numerous
difficulties which stand in the way of the precise measurement of consumer’s
surplus, e.g.,

A Complete list of demand prices is not available: We are aware only of a

part of the demand schedule. What we may be prepared to pay for
certain units is all a guess-work.

Consumer’s surplus in the case of necessaries of life and conventional

necessaries is indefinite and immeasurable.

The incomes of the consumers differ: Some consumers are rich, while
others are poor. They all pay the same price. Thus, the poor consumer makes
a greater sacrifice to get a commodity. This difference in the consumer’s

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 circumstances makes the measurement of consumer’s surplus difficult and
inexact.

Consumers differ in sensibilities: Every consumer has his own tastes and
sensibilities, and is therefore prepared to offer different amounts for the
same commodities.

Marginal utility of money changes: As we go on buying a commodity, less

and less amount of money is left with us. Hence marginal utility of each unit
of money increases with every successive purchase of a commodity. If we
ignore this change in the utility of money, our calculations of the consumer’s
surplus cannot be scientifically accurate.

The utility of the earlier units of a commodity decreases and this decrease is
not taken into account when calculating the consumer’s surplus.

Then, there is the difficulty arising out of the presence of substitutes. If there
were no tea, the utility of coffee would have been much greater, and vice -a-
versa.

Conclusion:
We may conclude by admitting that the exact measurement of
consumer’s surplus in a market is impossible. But on that account we cannot say
that the concept of consumer’s surplus is of no value. We can have some estimate
of consumer’s surplus, rough as it may be. Even this is of very great practical
value.

Rehabilitation of the surplus by Hicks: Concept of Consumer’s Surplus :

It may also be added that Prof. J.R. Hicks has given a solution of the difficulty
arising out of the immeasurability of utility and has thus rehabilitated the doctrine
of consumer’s surplus. He approaches it in terms of ordinal utility function or
indifference curve technique. He has given a measure of consumer’s surplus
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without assuming utility to be measurable and marginal utility of money to be
constant.

Importance of Consumer’s Surplus:

The idea of consumer’s surplus is not merely bookish.
It has great practical importance and is useful in a number of ways:

In Public Finance:
It is useful to a Finance Minister in imposing taxes and fixing their rates. He will
tax those commodities in which the consumers enjoy much surplus. In such cases,
the people would be willing to pay more than they actually pay at present. Such
taxes will bring in more revenue to the State. They will also mean comparatively
less hardship than if taxes were imposed on commodities which do not yield much
consumer’s surplus.

To the Businessman and Monopolist:

To the businessman also the concept is very useful. He can raise prices of those
articles in which there is a large consumer’s surplus. In such cases, the consumers
are willing to pay more than the prevailing price. The seller will be able to raise
price especially if he is a monopolist and controls the supply of the commodity.

Comparing Advantages of Different Places:

Our knowledge of consumer’s surplus proves useful when we compare the
advantage of living in two different places. A place where there are greater
amenities available at cheaper rates will be better to live in. In these places, the
consumers enjoy large surplus of satisfaction. Consumer’s surplus thus indicates
conjuncture advantages, i.e., the advantages of environment arid opportunities.

Distinction between Value-in-Use and Value-in-Exchange:

Consumer’s surplus draws a clear distinction between value-in-use and value-in-
exchange. Commodities like salt and match-box have a great value-in-use but
much less value-in-exchange. Being necessaries and cheap things, they yield,
however, a large consumer’s surplus. The consumer’s surplus depends on total
utility, whereas price depends on marginal utility.

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 Measuring Benefits from International Trade:
Consumer’s surplus measures benefits from international trade. We can import
things cheaply from abroad. Before importing them, we were paying more for
similar home- produced goods. The imports, therefore, yield a surplus of
satisfaction. We would have paid for them more than what we actually pay. This is
consumer’s surplus. The larger this surplus, the more beneficial is the international
trade.

Criticism of Consumer’s Surplus:

The concept of consumer’s surplus has been criticized on several grounds:

Imaginary:
It is said that this is a purely imaginary idea. You just imagine what you are
prepared to pay and you proceed to deduct from that what you actually pay. It is all
hypothetical. One may say that one is prepared to pay anything. Hence it is unreal.

Difficult to Measure:

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It is difficult to measure consumer’s surplus exactly. Few can say what they would
be prepared to pay for a thing. Besides, different people are prepared to pay
different amounts. It would be a hopeless task to put down how much each
individual would be willing to pay. Hence the total consumer’s surplus in the
market cannot be measured.

Surplus Exhausted:
It is pointed out that if the consumer knew that any such thing existed, he would go
on buying more and more till the surplus utility he enjoyed disappeared. This is
wrong. A consumer does not run after a surplus yielded by one commodity. He has
to weigh the utilities of other commodities too.

Not Applicable to Necessaries:

The idea of consumer’s surplus does not apply to the necessaries of life or
conventional necessaries. In such cases the surplus is immeasurable. What would
not a man be prepared to pay for a glass of water when he is dying of thirst?

Dr. Marshall has given a detailed reply to all these points of criticism. He points
out that the concept is not as unreal as it is supposed to be. A man living in a city
enjoys many amenities at low prices. If a man living in a distant village were keen
to enjoy them, he would have to spend much more.

Thus a man earning Rs. 1000 per month in city derives greater satisfaction from its
outlay than a man having the same income in some remote village. The man in the
city enjoys a consumer’s surplus, because he can have more things and at lower
prices.

Hick’s Criticism:
The Marshallian measure of consumer’s surplus has been severely criticised. A
very serious objection against the Marshallian measure of consumer’s surplus with
the help of demand curve (or marginal utility curve) is that it is based on the twin
assumptions that utility is measurable and that the marginal utility of money
remains constant as a person spends more of it on a particular good.

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Economists like Hicks and Allen have contended that utility is a subjective
phenomenon and hence cannot be measured in concrete terms. Further, they
contend that the assumption of the constancy of marginal utility of money is not
valid. Marshall’s assumption of constant marginal utility of money ignores the
“income effect” of the price change, which is often important.

Marshall defended his assumption by pointing out that since consumer spends only
a small fraction of his income on a particular good, the marginal utility of money
does not change to any significant extent. But this need not necessarily be the case.

On the other hand, Prof. J. R. Hicks has rehabilitated the concept of consumer’s
surplus by explaining it in terms of ordinal utility function or indifference curve
technique. He has given a measure of consumer’s surplus without assuming utility
to be measurable and the marginal utility of money to be constant.

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Example:
Let us take a look at an example of consumer surplus.

No. of units. Marginal utility Price (Rs.) Consumer’s

Surplus

1 30 20 10

2 28 20 8

3 26 20 6

4 24 20 4

5 22 20 2

6 20 20 0

7 18 20 -

From the table above, we see that as the consumption increase from 1 to 2 units,
the marginal utility falls from 30 to 28. This diminishes further as he increases
consumption.

Now, Marginal utility is the price the consumer is willing to pay for that unit. The
actual price of the unit is fixed.

Therefore, the consumer enjoys a surplus on all purchases until the sixth unit.
When he buys the sixth unit, he is in equilibrium, since the price he is willing to
pay is equal to the actual price of the unit.

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Real World Example of a 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 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, they raise their ticket prices to $300
each.

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 CONCLUSION
KEY TAKEAWAYS

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 the benefit or good feeling of getting a good deal.

Consumer surplus always increases as the price of a good falls and decreases
as the price of a good rises.

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