Consumer Surplus
French engineer A. J. Dupuit originally proposed the theory of consumer Surplus in 1844. Alfred Marshall in his book(1890) "Principle of Economics," further developed and popularized the concept of consumer and producer surplus. Depuit proposed this principle to gauge the societal benefit of public assets and services, such as surface breeze canals, roadways, etc. The price of an item is always less than what a consumer is willing to pay for it, meaning that the satisfaction he receives from buying it exceeds the price paid for it. Professor Boulding has renamed consumer surplus as "Buyers surplus". Cheaper commodities yield a substantial surplus to consumers. The volume of consumer surplus is larger in advanced countries whereas smaller in developing countries. If the government of a country imposes more tax or excise duty on necessary goods, prices will go up, and consequently, people's social surplus will be reduced.
Is consumer surplus possible in a market?
If we overlook the inter-individual disparities in income, preferences, fashion, etc., we can broaden the scope of consumer surplus in a market. By simply adding up the consumers that result from each individual purchase in the aggregate, we can calculate the consumer surplus that arises overall. Similar to how the market demand curve is created by combining the individual demand curves, the aggregate consumer surplus is created by adding all of the individual consumer surpluses.
Assumption of the law of consumer's surplus
- The anticipated price must exceed the actual price.
- The price of a commodity must be higher than or equal to marginal usefulness.
- Cardinal numbers can be used to quantify utility ( utils).
- A consumer is a sensible individual.
- Money's marginal utility is constant.
- Commodity prices ought to remain steady.
- Each commodity unit needs to be homogeneous.
Area ARQO displays the overall utility that s/he receives from OQ quantity. But the area OQRP indicates the entire amount he paid for the OQ quantity. Consumer surplus is represented by the difference between the two areas (ARQO - OQRP) or Triangle APR. The surplus of the consumer and the cost of the goods are inversely correlated. The surplus of the consumer rises if the price of the commodity decreases. On the other hand, if the cost of the good increases, the surplus of the consumer decreases.
When the market price line increases from PR to P1R1 then there is a decrease in consumer surplus.
The consumer surplus can be calculated by deducting the entire cost from the total utility or satisfaction. Consumer surplus is the amount that consumers are willing to pay more than a commodity's actual price.
Consumer surplus is therefore equal to Ready to Pay (Willingness to Pay) – The actual Price of a Good.
Alternatively, consumer surplus equals total utility minus total expenditure.
We can draw a marginal utility line to indicate how much consumers are willing to pay for various quantities of a commodity using a marginal utility. We clearly indicate the price the user actually pays as well as the amount or unit s/he consumes. Consumer surplus is defined as the portion that is below the marginal utility curve and above the price label.
Importance of Consumer's Surplus
- Calculating the monopoly price is important for estimating the cost of a commodity. Monopoly producers should consider consumer psychology when setting product prices. They increase the price of items and increase their profit when they believe that consumers are willing to pay more.
- It is useful in the formulation of tax policy, sometimes referred to as public finance. The tax strategy that maximizes public revenue with the fewest sacrifices is the optimal one. Because of this, the government imposes high taxes on goods when consumers enjoy significant surpluses.
- It is helpful in the area of cost-benefit analysis, a highly important instrument in the field of research and creating work when calculating consumer surplus, the cost, and the benefit of certain items. Similar to choosing a project, you need the benefit or surplus to outweigh the expense.
- The idea of consumer surplus can be used to compare a country's economic health. In developed countries, commodities are more affordable, allowing consumers to enjoy bigger surpluses, but in less developed countries, commodities are more expensive and allow for lower surpluses for consumers. So, a bigger consumer surplus is identified as a developed nation and vice-versa.
- Importing goods that are in high demand abroad is preferable to buying them domestically. It is not advisable to import products that have a significant consumer surplus in domestic production compared to import.
Limitation of Consumer Surplus
There are uncountable and fictitious bundles of blame. Money's marginal utility cannot remain constant because it ignores the impact of income prices. For products like gold and diamonds, consumer surplus is not applicable (Giffen goods).
Consumer surplus is the study of the benefit or surplus obtained from consuming the good. Therefore, in Prof. Boulding's opinion, it should be called Buyer's surplus rather than Consumer's excess.
Critics claim that it is an illusory idea because it is impossible for a person to actually receive greater satisfaction than was paid for. In truth, nobody is willing to pay more than the asking price.
The utility concept is another area of doubt. The utility received from the consumption of a good or service cannot be quantified.
There is no chance of consumer surplus if the prospective price is smaller than the current price. Because there is no assurance, there will always be a surplus.
Although money's marginal utility is constant in a consumer surplus, in reality, it depends on the amount of money available. Money's marginal utility rises when its quantity declines and vice versa.
Any commodity's utility depends on other commodities, however, this theory does not address the function of complementary and interchangeable items.