Consumer
Surplus
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Have you ever been
absolutely indifferent between buying some good at the going price versus
doing completely without it? If the market price of something you bought was
truly the maximum amount that you would willingly pay for the good, then you
received no net gain from its purchase.
Consumer surplus is the difference between
the amounts people would willingly pay for various amounts of specific goods
and the amounts they do pay at market prices.
The key
to exploring this concept graphically requires recognizing that we can look
at individual demand curves for a specific good from two different
perspectives:
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1. Demand curves
are conventionally viewed as answers to the question, “How much will be
bought at each possible price?” The quantity demanded depends on the price.
Thus, in Figure 1, at the market price of $50 per video game, this video
enthusiast is in equilibrium at point d
and buys 10 DVDs per year.
2. Alternatively,
we might view demand curves as graphing answers to the question, “If people
have certain amounts of good X,
what is the most they would willingly pay for an extra unit of X?”. This alternative perspective
views price as depending on quantity.
Both
approaches yield the same demand curves. Thus, this first figure also
indicates that the subjective value (demand price)of the tenth video game
per year is $50 at point d. The
ninth game yielded a subjective value of $55, and having an eleventh video
game would be worth only $45 to this player.
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The
view that a good’s marginal value to an individual depends on the amount
consumed is a key to specifying in monetary terms the satisfaction gained
from being able to buy at a single market price. In this case, this video
game fanatic will pay $500 per year for video games, which equals the area
of rectangle 0bda in the Figure
2.
The
issue, however, is how much this person would be willing to pay for ten new
games instead of having zero new
video games to play. And the answer, as seen in Figure 3, is that this
hobbyist would be willing to pay an amount equal to the total area under
the demand curve up to the equilibrium quantity, for a total of $750
annually. This is the area of the trapezoid 0cda.
Consumer
surplus is the difference between the total subjective value of having a
specific quantity of a good instead of doing without, and equals the total
subjective value minus the amount actually paid. Thus, the light green
triangle bcd represents consumer
surplus in this example.
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In
cases where we can represent consumer surplus with simple linear demand
curves and fixed market price, this is roughly the area below the demand
curve but above the price line, assuming that income effects are trivial.
This simple approach
can be used as a first approximation of the gains associated with buying a
good, and gains or losses of consumer surplus can also be a useful indicator
of the relative efficiency generated by private markets or government
policies. However, this geometric approach to calculating consumer surplus
has some serious limitations. For example, if we are evaluating the
efficiency of a policy that affects numerous people, using this approach
implicitly assumes that utility or satisfaction can be cardinally measured
in monetary terms, that an individual’s satisfaction from an extra dollar
is not affected by the individual’s income level, and most critically, that
all the individuals affected derive cardinally comparable amounts of
satisfaction from the last dollar allocated in the market being analyzed.
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Many economists are
convinced that failure of the real world to accord with these strong assumptions
is a fatal flaw, and that the concept consequently has no relevance for
economic policy or social welfare. The alternative concept of compensating variation avoids some of
the weaknesses of consumer surplus as a foundation for analyses of social
welfare, but is somewhat more difficult to apply empirically. Thus, even
though consumer surplus cannot be measured quantitatively in a cardinal
fashion, this concept does permit some useful qualitative assessments of such
things as the efficiency of some government policies.
See also the concept of compensating variation.
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