Consumer Surplus- Meaning, Measurement & Importance

Consumer Surplus

Meaning of Consumer Surplus

The concept of consumer surplus was first of all put across in 1844 by a French engineer and economist Dupuit and was called Consumer’s Rent. But Marshall in his famous book ‘Principles of Economics’ gave this concept the name of consumer’s surplus. In actual life, when we buy a commodity for consumption, we gain some utility by consuming it, at the same time we lose utility in terms gained is usually higher than the utility lost. This concept is used to explain the gap between total utility that a consumer gets from the consumption of certain commodities and the total money value which he actually pays for the same. Consumer surplus is the difference between what we would pay and what we have to pay.

Definitions:

In the words of Marshall, “The excess of the price which he would be willing to pay rather than go without the things over that which he actually does pay is the economic measure of this surplus satisfaction.”

According to Koutsoyiannis, “Consumer’s surplus is equal to the difference between the amount for a commodity X which a consumer actually pays and the amount that he would be willing to pay for this quantity.’

Measurement of Consumer’s Surplus

Two main approaches regarding measurement of consumer surplus are: (1) Marshallian Approach and (2) Hicksian Approach.

Marshallian Approach to Consumer’s Surplus

Marshall’s concept of consumer surplus is based on the law of diminishing marginal utility. As the consumer goes on consuming successive units of the same commodity its utility goes on declining. This concept is based on the difference between total utility and marginal utility.

Consumer Surplus = Total Utility – Marginal Utility

OR

Consumer Surplus= Person Willing to Pay – Actual Pay

The above can be explained with the help of practical examples:

1. Consumer’s surplus on single unit purchase:

   Consumer surplus is possible even when consumer purchase only one unit of a commodity.

Let us suppose a student is willing to pay Rs. 50 for a particular book and when he actually go to market and purchase Rs. 30. Thus Rs. 20 (Rs. 50-30) is the consumer’s surplus.

Assumption: Concept of consumer surplus is based on the following assumptions:

• Consumer’s surplus is based on law of diminishing marginal utility.
• Every commodity is an independent commodity, or it has no substitute.
• Utility can be measured in cardinal numbers.
• Marginal utility of money remains constant.
• Price of the commodity is given.

2. Consumer’s surplus on a multi-unit commodity :

   In our real life one purchases number of units of a particular commodity. As the consumer goes on consuming successive units of the same commodity its utility goes on declining. A point is reached where the marginal utility comes down to be equal to price, i.e. if he consumes the 6th unit, he derives zero marginal R utility whereas he pays the price as Rs. 2. A rational consumer will not consume that commodity. This can be shown in the following diagram:

In the diagram AB is a demand curve of a consumer, OR is the market price. The price line is parallel to X-axis because of perfect competition. At point P the marginal utility curve AB intersect the market price curve OR. Thus for OQ quantity the consumer derives utility as AOQP whereas he pays ROQP. Thus triangular shaded area ARP is consumer’s surplus.

Consumer’s Surplus = Total Utility – Total Price

OR

TU-MU X No. of units purchased

Importance of Consumer’s Surplus

The idea of consumer’s surplus has got both theoretical and practical importance.

1. Theoretical Importance-

   The concept of consumer’s surplus enables us to realise the difference between ‘value-in-use’ and ‘value-in-exchange.’ In our real life, we realise almost daily that some commodities are very useful and also cheap in the market e.g. match box, post card, salt, newspaper etc. For them we are prepared to pay much more than we actually pay, if the alternative is to go without them.

2. Practical Importance-

   The points of practical importance may be mentioned as below:

• The concept of consumer’s surplus enables us to measure the benefit arising from international trade. By entering into trade with other countries, we import certain commodities which happen to be cheaper. Before we import them we are paying more for the same commodity. Now, these commodities yield surplus of satisfaction which is measured by the excess of price we were paying. The larger this surplus, the more beneficial is the international trade.
• The concept of consumer’s surplus is not only of importance to business men or to Finance Minister, but is important to every common man, who may be interested in the welfare economics. This is also of high practical value to the political leaders and to the trade unionists.
• A business man or a monopolist takes the advantage of the knowledge about consumer’s surplus. He finds that it is easy to raise the prices if the commodity is yielding large surplus of satisfaction to the consumers. As a matter of fact, no businessman raises his price to such level as to absorb the whole of consumer’s surplus. In order to have goodwill of his customers he leaves a considerable amount of surplus with the consumers.
• The doctrine of consumer’s surplus enables us to compare the advantages of environment and opportunities. These conjectural benefit make it possible to compare the conditions of one period with that of the other period or of one country with that of another country. Thus, it becomes easy to compare the economic conditions of the people at different times and of different countries. The larger the consumer’s surpluses, the better off are the people.
• In the field of public finance, the idea of consumer’s surplus is of great importance. The imposition of a tax may cause much decrease in the consumer’s surplus. If it is so, it will not be desirable for the Finance Minister to impose this tax.. Similarly, a grant of a bounty will increase consumer’s surplus. The success of a Finance Minister depends upon his knowledge about consumer’s surplus. While levying taxes on commodities, he should know how much loss is caused in the amount of consumer’s surplus to the people. Levying of taxes means that the prices of commodities will rise. If the prices rise to a great extent, generally the state will not have sufficient income for its expenditure.

Difficulties of Measurement of Consumer’s Surplus

The measurement of consumer’s surplus presents several difficulties. The important of these are:

1. Complete list of demand prices is not available. We ourselves do not know, for example, except by mere guess-work, how much money would offer if we are threatened with an almost complete loss of a commodity. We can, therefore, at best have only a part of the demand schedule.
2. Consumer’s surplus in the case of necessaries is indefinite and fantastic. Rather than die of hunger, a man would sacrifice the whole of his property for a few loves or a handful of rice.
3. The income of the consumers differs. The difference in circumstances of the consumers renders the measurement of consumer’s surplus difficult.
4. Individual tastes and sensitivities differ. As a result the utility of a commodity is different amounts for the same commodity.
5. The utility of money changes. With every successive purchase of a commodity, the marginal utility of each unit of money increases. Our calculation is based on the assumption that the utility of money is constant and cannot be scientifically accurate. The assumption that the spending of a little more or less of money does not affect the marginal utility of money is highly arbitrary and questionable.
6. As a person goes on purchasing more and more units of a commodity, the intensity of his desire for earlier units diminishes. This means that as he increases purchases, his demand prices for earlier units fall along with his satisfaction from their consumption. It becomes necessary, therefore, to redraw the demand schedule of earlier purchases at a lower level of price.
7. The presence of substitutes or complementary goods also presents a difficulty. If there were no tea, the utility of coffee would have been much greater. This is the case with all the substitutes.

Important links

• Elasticity of Demand- Definition, Degree, Measurement
• Price Elasticity- Factors & Importance
• Demand and Demand Curve- Explanation & Exception
• Circumstances in which Demand Curve Slopes Upward
• Law of Demand- Definition, Chief Characteristics
• Importance of the Law of Diminishing Marginal Utility

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