Introductory Economics

Introduction to Consumer's surplus

• The concept of consumer’s surplus was first of all evolved by Dr Alfred Marshall.
• According to him consumer surplus is “Excess of price which a consumer would be willing to pay, rather than go without a thing over that which he actually does pay.”
• The amount of money which a person is prepared to pay for good indicate the amount of utility he derives from that good, the greater the amount of money he is willing to pay, greater the utility he will obtain the good. Therefore the marginal utility of a unit of a good determines the price a consumer will be prepared to pay for that unit.
• The total utility will get from a good will be given by the sum of marginal utilities of the units of good purchased and the total price which he actually pay is equal to the price per unit multiplied by the number of units purchased, thus,

Consumer Surplus =what a consumer is prepared to pay minus what he actually pays =Sum of marginal utilities - (price X No. of units purchased)

Measurements of consumer’s surplus:
There are two approaches to measure the consumer surplus;

1. Marshallian approach
2. Hicksian approach

1. Marshallian approach:

• This approach is based on cardinal utility approach. The concept is based on the difference between total utility and marginal utility. A will stop buying a commodity at a point where the sacrifice made by him in terms of the price of the commodity is equal to its marginal utility.

Assumptions: Concept of consumer’s surplus is based on the following assumptions.

a. Utility can be measured in cardinal numbers
b. Marginal utility of money remains constant and utility of a commodity can be expressed in terms of money.
c. Every commodity is an independent commodity or it has no substitute. It means utility of a commodity is not influenced by the utility of another commodity.
d. Income, fashion, custom, taste etc. of the consumer remains constant.
e. Concept of consumer’s surplus is based on demand curve or marginal utility. Thus all the assumptions of demand curve also apply to this concept.

Explanation:
The concept of consumer’s surplus can be explained with the help of following table and figure.

Units of a good	MU/ Price	Actual price	Consumer’s surplus
First unit	50	25	25
Second unit	40	25	15
Third unit	35	25	10
Fourth unit	25	25	0
Total	150	100	50

From this table it can be seen that
Total utility = 50+40+35+25 =150
Price or marginal utility sacrificed =25X4 =100
Consumer’s surplus = 150-100 =50.

In figure below in which number of units of good X are shown on X-axis and price on Y-axis. The consumer is willing to pay 50 paisa for the first unit of good X and 40 for the second unit and so on. Hence he is willing to pay OABCD price, however, he actually pays OPCD price. Hence area equal to ABCP is consumer’s surplus.

Hicksian Concept of Consumer’s Surplus: Prof Hicks has attempted to measure consumer’s surplus with the help of ordinal utility (indifference curves). It is illustrated as below in the figure.

• In the figure, units of good X are shown on X-axis and money income of the consumer on Y-axis. Suppose the income of the consumer is OM. With this money he can buy ON units of good X, therefore MN is the price line. Slope of price line OM/ ON expresses the price per unit. Price line is tangent to IC2 at E i.e. consumer is at equilibrium.
• He buys OQ units of good X by paying MA units of money.
• Supposing the consumer does not know the price prevailing in the market. In order to get OQ units of good X the price he would be willing to pay can be ascertained from indifference curveIC1 touching point M. It is evident from the indifference curve IC1 that to buy OQ units of good X the consumer is willing to pay MB units of money, whereas he does actually pay MA units of money income. Thus the consumer is getting a surplus of (MB-MA) equal to AB amount of money.