The concept of consumer surplus was first formulated by Dupuit in 1844 to

measure social benefits of public goods such as canals, bridges, national

highways. Marshall further refined and popularised this in his Principles of
Economics published in 1890.
The concept of consumer surplus became the basis of old welfare economics.
Marshalls concept of consumers surplus was based on the cardinal
measurability and interpersonal comparisons of utility. According to him,
every increase in consumers surplus is an indicator of the increase in social
welfare. As we shall see below, consumers surplus is simply the difference
between the price that one is willing to pay and the price one actually
pays for a particular product.
Concept of consumers surplus is a very important concept in economic
theory, especially in theory of demand and welfare economics. This concept
is important not only in economic theory but also in formulation of economic
policies such as taxation by the Government and price policy pursued by the
monopolistic seller of a product.

Two basic assumptions made by Marshall in his measurement of

consumers surplus are:
(1) Utility can be quantitatively or cardinally measured, and
(2) When a person spends more money on a commodity, the marginal utility
of money does not change or when the price of a commodity falls and as a
result consumer becomes better off and his real income increases, the
marginal utility of money remains constant.
Uses and Applications of Consumer Surplus:
The concept of consumer surplus has several applications both in economic
theory and economic policy. This concept has been used to resolve waterdiamond paradox of value theory, to explain the effects of taxes and
subsidies on peoples welfare, to make cost-benefit analysis of public
projects, to show gains from trade etc.

We will explain below some of the applications of the concept of

consumer surplus:
Explaining Value Paradox (Water-Diamond Paradox):
One of the most famous puzzles in economic theory is why diamonds are
more expensive than water. Water is essential for life; it is so useful that
without its consumption one cannot live or survive. On the other hand,
diamonds, though attractive and beautiful, satisfy less important human
needs than water.
Then, how it can be that in the market a less useful commodity like diamond
is so expensive and a highly useful commodity as water is very cheap. Some
thinkers in the past therefore complained that something was wrong with the
market system which determines high price of commodities such as
diamond, gold etc. which are least useful and low price of a commodity such
as water which is necessary and highly useful.
Therefore, this came to be known as value paradox or water-diamond
paradox. However, for modern economists there is no paradox about it as
they are able to explain the large price differential between water and
diamond.
The notion of marginal utility or marginal benefit of a commodity and the
concepts of consumer surplus based on it can be used to resolve the waterdiamond paradox. The marginal benefit or marginal valuation per litre of
water for the consumer is very low as the actual supply of water per period is
very large.
On the other hand, the marginal utility or marginal benefit of diamonds is
very high because the amount of diamond actually available is very small. If,
in fact, only a few litres of water were available marginal valuation of water
would have been much greater than that of diamonds.
Note that marginal valuation of a commodity reflects how much amount of
money consumer is prepared to pay for a commodity. This indicates marginal
utility or use-value of the commodity for the consumer. It is worth noting that
downward-sloping demand curve for a commodity can be interpreted as
showing the marginal valuation or marginal utility in terms of money to the
consumer of various units of a commodity.

If the quantity actually available of a commodity in the market is very large,

its marginal valuation or marginal utility will be very small, though its total
use-value or total benefit may be very large. On the other hand, as they
actually available quantity of a commodity such as diamonds, gold etc. is
very small, its marginal valuation or marginal utility is very high, though its
total value-in-use or total utility is small.
Market price of a commodity is determined not by its total use-value but by
its marginal valuation or marginal utility which in turn depends on the
actually available quantity. The total use-value or total utility which a
consumer gets from a quantity of a commodity equals the amount actually
paid and the consumer surplus he obtains from it.
In case of water market price as determined by its marginal utility is very low
but consumer surplus from it is very large. On the other hand, in case of
diamond due to their greater scarcity, marginal utility and hence its price is
very high but consumer surplus from it is very small. Thus, the concept of
consumers surplus shows that price should not be confused with total usevalue of a commodity and this helps us to resolve the water-diamond
paradox.

Use of Consumer Surplus in Cost-Benefit Analysis:

An important application of consumer surplus is its use in cost-benefit
analysis, especially of public investment projects. In fact, Dupuit, the
originator of the idea of consumer surplus in his paper. On the Measurement
of Public Works in 1844 used the concept of consumer surplus for describing
the impact of public investment projects on social welfare. In recent years
Prof. E.J. Mishan has based his cost-benefit analysis on consumer surplus
approach.
Consumers surplus has been treated as benefits in various cost-benefits
analysis of investment projects. The cost-benefit analysis has become very
popular these days to judge the desirability of public investment in particular
projects.
It should be noted that costs and benefits in cost-benefit analysis do not
merely mean money costs and money benefits but real costs and real
benefits in terms of satisfaction and resources. Further, cost-benefit analysis

looks at costs and benefits from social point of view; it is concerned with
social benefits and social costs.
The amount of consumers surplus expected to be derived from certain
projects such as a bridge, road, park, dam etc. are considered as an
important benefit flowing from these projects. The benefit of a new motor
way or flyover is estimated by reference to the expected savings of time and
cost of fuel by all motorists who will make use of the new road or flyover.
The concept of cost-saving however, as we shall see below, is derived
directly from the concept of consumers surplus. Thus, prior to the
introduction of the new flyover in question, the consumers surplus from
using this particular route is the triangle under the relevant demand curve
which measures the maximum sum motorists are willing to pay above the
amount they currently spend on the journey.
Evaluating Gain from a Subsidy:
The concept of consumer surplus can be used to evaluate the gain from
subsidies. The Government these days provides subsidies on many
commodities such as food-grains, fertilizers, power. Let us take the example
of subsidy on food-grains production being given by the Government.
Suppose the subsidy reduces the price of food-grains from Rs. 400 to Rs. 300
per quintal. As a result of the fall in price of food-grains due to subsidy be ing
provided for its production, the quantity demanded of food-grains increases
from 10 thousand quintals (Q1) to 12 thousand quintals (Q2).

Now, the question to be answered is what will be net social benefit or gain
from this subsidy. Consider Fig. 14.7 where DD is the demand curve for foodgrains which, as explained above, can also be interpreted as marginal utility
(or marginal valuation) curve. To begin with, PS is the supply curve, assuming
constant cost conditions. Price determined is OP or Rs. 400 per quintal.
With the grant of subsidy equal to Rs. 100 per quintal, supply curve shifts
below to P1S1and as a result price falls to OP 1 or Rs. 300 per quintal. With the
reduction in price to OP1(i.e., Rs. 300 per quintal) quantity demanded
increases to from OQ1 to OQ2.
It will be seen from Fig. 14.7 that the total gain in consumer surplus is equal
to the area PACP1 which can be divided into two parts, namely, the area
PABP1 ( = R.Q1) where R is the subsidy per quintal of food-grains plus triangle
ABC, which equals 1/2 R.Q.
Thus, the gain in consumer surplus = R.QX + R.Q.
Where R.Q1 represents the reduction in expenditure on the quantity Q 1 that
would have cost Rs. R (=Rs. 100) per quintal more without subsidy. Thus
R.Q1 represents the benefit or gain in consumer surplus to those who were
purchasing food-grains before the grant of subsidy but would now do so at a
lower price.
The amount 1/2 R.AQ represents the gain in consumer surplus due to the
increase in quantity demanded at a lower price made possible by the grant
of subsidy. Thus, the total gain in consumer surplus is the area PACP 1 which
equals R.Q1 + 1/2 R.AQ.
But the cost of subsidy to the Government is R.Q 2 or the area P1 PEC which is
greater than the gain in consumer surplus by the area of the triangle ACE.
Thus, if the buyers would have been given the lump-sum grants equal to the
area PACP1 they would have been as well off as in case of subsidy which
costs more to the Government. Thus, subsidy causes excess burden equal to
the area of triangle ACE as compared to the lump sum grant.
EXAMPLEYou go into a store and find a sweater that you like. The price tag on it is $50.
You don't notice another sign saying that there's a sale on these items and
that the discount is 40%. You decide you value the sweater more than $50

and so you go to the sales clerk to buy it. When she goes to ring you up, she
tells you that there's a 40% discount. So you pay $30. You get at least $20 in
consumer surplus.
AUCTIONTRANSPORTATION
CARS
What is consumer surplus?
When there is a difference between the price that you pay in the market and
the value that you place on the product, then the concept of consumer
surplus becomes a useful one to look at. This is an important idea that you
can
use
on
many
occasions
in
your
exams.

Consumer surplus and price elasticity of demand

How is consumer surplus affected by the elasticity of a demand curve?

1. When the demand for a good or service is perfectly elastic,

consumer surplus is zero because the price that people pay matches
exactly what they are willing to pay.
2. In contrast, when demand is perfectly inelastic, consumer surplus is
infinite. In this situation, demand does not respond to a price change.
Whatever the price, the quantity demanded remains the same. Are
there any examples of products that have such zero price elasticity of
demand? Perhaps the closest we get is a life-saving product with no
obvious substitutes - in this situation, consumers' willingness to pay
will be extremely high
3. The majority of demand curves in markets are assumed to be
downward sloping. When demand is inelastic (i.e. Ped<1), there is a
greater potential consumer surplus because there are some buyers
willing to pay a high price to continue consuming the product.
Businesses often raise prices when demand is inelastic so that they
can turn consumer surplus into producer surplus!
Consumer surplus with elastic and inelastic demand curves

PED and consumer surplus

When there is a shift in the demand curve leading to a change in the
equilibrium market price and quantity, then the level of consumer surplus
will change too

Consumer surplus is infinite when the demand curve is inelastic and zero in
case of a perfectly elastic demand curve.

Changes in consumer surplus

Price discrimination and consumer surplus

Producers often take advantage of consumer surplus when setting

prices

If a business can identify groups of consumers within their market who

are willing and able to pay different prices for the same products, then
sellers use price discrimination this is a way of turning consumer
surplus into producer surplus, put simply to make higher revenues and
profits.

Airlines and train companies are expert at this, extracting from

consumers the price they are willing and able to pay for flying to
different destinations are various times of the day, and
exploiting variations in elasticity of demand for different types of
passenger service.

You will always get a better deal / price with airlines such as EasyJet
and Ryan Air if you are prepared to book in advance. The airlines are
happy to sell tickets more cheaply because they get the benefit of
cash-flow together with the guarantee of a seat being filled. The nearer
the time to take-off, the higher the price

If a businessman is desperate to fly from Newcastle to Paris in 24 hours

time, his or her demand is said to be price inelastic and the
corresponding price for the ticket will be much higher.

Price discrimination and market power

One of the main arguments against firms with monopoly power is that they
can exploit their monopoly position by raising prices in markets where
demand is inelastic, extracting consumer surplus from buyers and increasing
profit margins at the same time.

Consumer surplus[edit]
Consumer surplus is the difference between the maximum price a consumer
is willing to pay and the actual price they do pay. If a consumer would be
willing to pay more than the current asking price, then they are getting more
benefit from the purchased product than they initially paid. An example of a
good with generally high consumer surplus is drinking water. People would
pay very high prices for drinking water, as they need it to survive. The
difference in the price that they would pay, if they had to, and the amount
that they pay now is their consumer surplus. Note that the utility of the first
few liters of drinking water is very high (as it prevents death), so the first few
litres would likely have more consumer surplus than subsequent liters.
The maximum amount a consumer would be willing to pay for a given
quantity of a good is the sum of the maximum price they would pay for the
first unit, the (lower) maximum price they would be willing to pay for the
second unit, etc. Typically these prices are decreasing; they are given by the
individual demand curve. For a given price the consumer buys the amount
for which the consumer surplus is highest, where consumer surplus is the
sum, over all units, of the excess of the maximum willingness to pay over the
equilibrium (market) price. The consumer's surplus is highest at the largest
number of units for which, even for the last unit, the maximum willingness to
pay is not below the market price
The aggregate consumers' surplus is the sum of the consumer's surplus for
all individual consumers. This can be represented graphically as shown in the
above graph of the market demand and supply curves.
The concept[edit]
According to Law of diminishing marginal Utility, after a certain point, the
satisfaction derived by the consumer, after each successive unit, derived
become lesser and lesser. When he buys more and more, even though his
total utility may keep increasing up to certain point, his marginal utility will
keep decreasing, We may be willing to offer higher price for many goods but
the actual price may be less. Consumers surplus indicates the difference
between the Price we would be willing to offer and the price we actually
offered.[2] If the consumer buys three units of commodity at Re one per unit,
the first unit offers more satisfaction than the second unit and the second
unit offers more satisfaction than the third unit. Since he would have
purchased all the three units at the same price the satisfaction he had
derived for second and first unit would have been more than the price
offered and this difference is called Consumers surplus.[3] The utility he

derives from a product is the gain and the price he pays is the loss he
sustains while buying a product. He will buy any product as long as his
satisfaction or utility which is his gain is more than the price he pays for
which is his loss.[4] As soon as both match he will stop buying such products.
In real life there are several things where the person derives consumers
surplus. For example, he secures maximum from certain cheaper products
like salt, newspaper, electricity etc. It is often said that the behaviour of the
market, forces us to reveal our personal preferences is an extremely
important one and this opinion gets strengthened by this concept of
Consumers Surplus.[5]
Another way to define consumer surplus in less quantitative terms is as a
measure of a consumer's well-being. Some goods, like water, are valuable to
everyone because it is a necessity for survival. But the utility, or
"usefulness," of most goods vary depending on a person's individual
preferences. Since the utility a person gets from a good defines her demand
for it, utility also defines the consumer surplus an individual might get from
purchasing that item. If a person has no use for a good, there is no
consumer's surplus for that person in purchasing the good no matter the
price. However, if a person finds a good incredibly useful, consumer surplus
will be significant even if the price is high. An individual's customer surplus
for a product is based on the individual's utility of that product.
Definition[edit]
The Consumers surplus, may thus be defined, as the excess utility obtained
by the consumer over utility foregone or disutility suffered. It is measured by
the difference between the maximum price which the consumer is willing to
pay for a commodity rather than go without it and the price he actually pays
for it. In the words of Dr Marshall the excess of price which a person 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 of satisfaction. It
may be called Consumers surplus
Measuring Consumers surplus[edit]
The table and the diagram below explain process of measuring consumers
surplus
Sug Marginal Actu Consume
ar
Utility/Pr al
r's
Kilo ice Rs
Price Surplus

s
1
2
3
4
5
6

80
70
60
50
40
30

Rs
30
30
30
30
30
30

50
40
30
20
10
0

Consumer's Surplus
Marginal utility mentioned in the table indicates the marginal utility derived
from every unit of the product. This is the price we are willing to offer to the
product which is the potential price. Whereas in the market we offer the
market price which is the actual price. The difference between the potential
price and the actual price is the consumers surplus.
In the graph, X axis measures the Units of Sugar and the Y Axis indicates
the utility or the price. The shaded portion indicates the surplus derived from
each unit of product. When he buys the sixth unit of sugar the marginal
utility tend to become zero. He will buy no more In the market if the price
increases the Consumers surplus will decrease and if the price decreases
the consumers surplus will increase.
Application[edit]
1. It helps us to make comparison about peoples welfare between two
places. People living in urban areas due to variety of products being
offered tend to have more consumers surplus in comparison to rural
areas.
2. It helps us to measure the benefits of International trade. If the
importers tend to enjoy higher amount of Consumers surplus, the
country stand to gain

3. This concept helps to explain the doctrine of Value in Use and Value in
Exchange
4. This also help the Monopolists while fixing the price for their
product.The must not be overzealous and must fix the price in such a
way that the consumer enjoys certain amount of Consumers surplus
5. it helps Government to evolve a suitable taxation policy and helps
them in identifying products which could be taxed. Tax must be levied
in such a way that the consumer tend to enjoy consumers surplus.
6. It helps to understand the superiority of Direct Tax over indirect Tax.

When direct tax is levied the person has room to shift his burden to
other sources, whereas in the case of indirect tax, if it is going to affect
the consumers surplus of the product which attracts tax, the
consumer will abstain from buying the product as well.