The concept of consumer surplus is derived from the law of diminishing marginal utility. As per the law, as we purchase more of a commodity, its marginal utility reduces. Since the price is fixed, for all units of the goods we purchase, we get extra utility. This extra utility is consumer surplus.
Alfred Marshall, British Economist defines consumer’s surplus as follows: “Excess of the price that a consumer would be willing to pay rather than go without a commodity over that which he actually pays.”
Hence, Consumer’s Surplus = The price a consumer is ready to pay – The price he actually pays
Further, the consumer is in equilibrium when the marginal utility is equal to the price. That is, he purchases those many numbers of units of a good at which the marginal utility is equal to the price. Now, the price is fixed for all units. Hence, he gets a surplus for all units except the one at the margin. This extra utility is consumer surplus.
Let us take a look at an example of consumer surplus.
|No. of units||Marginal Utility||Price (Rs.)||Consumer’s Surplus|
From the table above, we see that as the consumption increase from 1 to 2 units, the marginal utility falls from 30 to 28. This diminishes further as he increases consumption. Now,
- Marginal utility is the price the consumer is willing to pay for that unit.
- The actual price of the unit is fixed.
Therefore, the consumer enjoys a surplus on all purchases until the sixth unit. When he buys the sixth unit, he is in equilibrium, since the price he is willing to pay is equal to the actual price of the unit.
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The concept of consumer surplus is illustrated graphically as follows:
In the figure, you can see that the X-axis measures the amount of commodity, while the Y-axis measures the price and marginal utility. Further, MU represents the marginal utility curve, sloping downwards. This indicates that as the marginal utility falls, the consumer purchases more units of the commodity and vice-versa.
Next, if OP is the price of a unit of the commodity, the consumer is in equilibrium only when he purchases OQ units. In other words, when marginal utility is equal to the price OP.
Further, the Qth unit does not yield any surplus since the price and marginal utility is equal. However, for the purchase of all units before the Qth unit, the marginal utility is greater than the price, offering a surplus to the consumer.
In Fig. 2 above, the total utility is equal to the area under the marginal utility curve up to point Q (ODRQ). However, for price = OP, the consumer pays OPRQ. Hence, he derives extra utility equal to DPR which is consumer surplus.
- It is difficult to measure the marginal utilities of different units of a commodity consumed by a person. Hence, the precise measurement of consumer’s surplus is not possible.
- For necessary goods, the marginal utilities of the first few units are infinitely large. Hence the consumer’s surplus is infinite for such goods.
- The availability of substitutes also affects the consumer’s surplus.
- Deriving the utility scale for prestigious goods like diamonds is very difficult.
- We cannot measure the consumer’s surplus in terms of money. This is because the marginal utility of money changes as a consumer makes purchases and his stock of money diminishes.
- This concept is acceptable only on the assumption that we can measure utility in terms of money or otherwise. Many modern economists are against the concept.
Learn Consumers Equilibrium here.
Solved Question on Consumer Surplus
Q: What are the two basic assumptions in the measurement of consumer surplus?
Ans: The basic assumptions are as follows,
- We are able to measure utility quantitatively
- A person spending more money on a commodity the marginal utility of money will not change, it remains constant.