Consumer surplus

Consumer surplus: Consumer surplus is the difference of what we are willing to pay and
what we actually pay.

According to Marshall, The excess of the price which he (i.e. consumer) would be willing to
pay rather than go without the thing over that which he actually does pay is the economic
measure of this surplus satisfaction..... It may be called Consumers surplus.
Example: Suppose I am willing to pay Rs 10 for the pen but the cost of the pen is only Rs 5.
So I actually pay Rs 5 for the pen.
So Consumer surplus = the price which the person willing to pay - price which he actually
pays
Consumer surplus = Rs 10 Rs 5 = Rs 5

Consumer surplus and the Law of Diminishing Marginal Utility: The concept of consumer
surplus may be derived from the law of diminishing marginal utility. Person all the time will
not be willing to pay more for the commodity. If the utility of the commodity is more, then
he will ready to pay more for the product. As the person uses the unit of the commodity,
each unit will meet with the less and less utility than before. Thats why for initial units,
consumer is willing to pay more than later units.


According to Alfred Marshall:

Consumers Surplus = Total Utility (Price Quantity)
Symbolically, C.S = TU (P Q)
where C.S=Consumers Surplus
TU=Total Utility
P=Price
Q=Quantity of the commodity
As TU = MU,
Where MU=the sum total of marginal utility
C.S = MU (P Q)

The idea will be clear from the table given below

Units of Commodity
Marginal Utility
(Imaginary price)
Market Price
(in Rupee)
Consumer's Surplus
1 50 10 50-10=40
2 40 10 40-10=30
3 30 10 30-10=20
4 20 10 20-10=10
5 10 10 10-10=0






Assumptions of consumer surplus theory: According to Marshalls theory, the main
assumptions of consumers surplus are

1-utility can be measured in terms of money.
2-No alternative commodities available
3-The customers income, tastes, preferences and fashion remain unchanged during the
analysis.
4-Marginal utility of money is constant
5-Concept of diminishing marginal utility
6- Marginal utility derived from the commodity under consideration is not influenced by the
marginal utilities derived from other commodities.

Consumers Surplus and Form of Market
In the calculation of consumers surplus, we assume a perfect market where the price are
same for all the units of the same commodity. We can measure consumers surplus for an
entire market (group of individual consumers) with the help of market demand curve and
market price line.



In this figure, DD represents market demand curve which shows the price that the group of
consumer is willing to pay for the successive units of a commodity. PB denotes market price
line. PB is horizontal, which implies that the market price is same for all units of the
commodity. The point E represents equilibrium position, where market demand curve
intersects market price line. OQ represents the quantity of the commodity that the
consumer purchases in the given price and equilibrium position.

ODEQ represents the money the consumer is ready to spend for OQ units of commodity.
However, OPEQ is the actual amount spent by the consumer to get OQ units of commodity
DPE is consumers surplus.

Difficulties of Measurement-The measurement of consumers surplus is not as simple as it
seems. There are numerous difficulties which create hurdle in the measurement of
consumers surplus.
1. A Complete list of demand prices is not available.
2. In the case of necessaries of life and conventional necessaries, Consumers surplus is
indefinite and immeasurable.
3. The income of the consumer does not remain same.
4. Change in Marginal utility of money.
5. Tastes and sensibilities are different for different consumers for the same
commodity.
6. There is the difficulty arising because of the presence of substitutes.

The concept of consumers surplus given by Marshall was criticised on several ground such
as it is imaginary and difficult to measure. A man cannot always say what he will be willing
to pay rather than go without the thing. The main point of criticism is that it is incapable of
precise numerical measurement.

Measurement of consumers surplus with Indifference curve
According to Hicks and Allen, utility is a subjective phenomenon and it cannot be measured
in terms of money.
Prof.J.R.Hicks has rehabilitated the concept of consumers surplus by approaching it in terms
of ordinal utility function or indifference curve technique.
Hicks theory on consumers surplus was based on following assumptions.

Marginal utility of money is not constant. It will increase with the decrease in the
stock of money.
Utility is subjective in nature so it cannot be measured in cardinal numbers.
Utility derived from a unit of a commodity is not independent. Instead, it is related to
previous units consumed.



Suppose the price in the market as represented by the price line ML, money with the
consumer, remaining the same. With this price in the market, he will be in equilibrium at
point H on a higher indifference curve IC2. And in this equilibrium position, he will actually
give up FH (=MT) amount of money for OA of commodity X. But independent of the price in
the market he was prepared to pay FR amount of money for OA of the commodity X
(indifference curve1). Thus he is paying less money for the same quantity (OA). HRTS is the
consumers surplus which the consumer is getting because of the fact of this particular
market price.

The concept of consumers surplus has great practical utility and serves as a tool of modern
economic welfare analysis.
It is useful to a Finance Minister in imposing taxes. He will impose tax on those commodities
in which the consumers enjoy much surplus.
For the monopolist also the concept is very useful. He can raise prices of those commodities
in which there is a large consumers surplus.
Consumers surplus measures benefits from international trade. By entering into trade with
another country, we can import certain articles which happen to be cheaper. Before
importing them, we were paying more for similar home- produced goods. The imports,
therefore, yield a surplus of satisfaction. The larger this consumers surplus, the more
beneficial is the international trade.

Thus, it is clear that the concept of consumers surplus is having a great practical value.