Note on Consumers Surplus

  • Note
  • Things to remember

CONSUMER SURPLUS

source:courses.byui.edu
source:courses.byui.edu

The concept of consumer surplus was introduced by A.J. Dupit in 1844. Later on, Alfred Marshall developed it in his book, "Principle of Economics" published in 1890.

The concept of consumer surplus is related to our daily life expenses. The excess of benefits from the consumption of a commodity over the sacrifice made in terms of price paid for the commodity is called consumer's surplus.

According to Alfred Marshall, ”Excess of the price which a consumer would be willing to pay rather go without a thing over that which he actually does pay is the economic measure of this surplus satisfaction. It may be called consumer surplus."

In other words of A.Koutsoyannis, ”Consumers Surplus is equal to the difference between the amount of money that consumer actually pays to buy a certain quality rather than go without it".

In short,

Consumers Surplus(CS) = WP - AP

Where,

WP = Willing to pay price

AP = Actual paid price

It is also expressed as:

CS =TU - TS

Where,

TU =Total utility or total benefit derived

TS =Total amount spent

ASSUMPTIONS OFTHE LAW OF CONSUMERS SURPLUS

  • Expected price should be more than actual price
  • Marginal utility must be greater equal to the price of commodity
  • Utility can be measured in cardinal number
  • Consumer is rational person
  • Constant marginal utility of money

The concept of consumer surplus for an individual consumer is represented below:

Unit of goods

Actual price

Price willing to pay

Consumers Surplus

1

60

120

60

2

60

100

40

3

60

80

20

4

60

70

10

5

60

60

0

AP=300

WP=430

C.S=130

In the above table, a consumer tends to assume amount which they are Willing to Pay (WP) but is always greater than Actual Pay (AP). When the consumer buys his 1st unit, then they are willing to pay 120 and the actual pay is 60 and the consumer surplus is 60. Again, when the consumer consumes 2nd unit, they are willing to pay 100 and the market price is always fixed. So, actual pay/price is 60 and consumer surplus is 40. This is used up to the 5th unit where consumers surplus is 0.

Consumers Surplus = WP - AP

= 430 - 300

= 130

Such data can be explained with the help of graphical representation.

s

In the above figure, X-axis measures the units of a commodity and Y-axis measures the MU or price willing to pay. The shaded part in the graph represents the consumer surplus that remains after deducting total cost from total utility.

CRITICISMS OF CONSUMER'S SURPLUS

  • Marginal utility of money is not constant

This law assumes that the marginal utility of money remains constant throughout the process of exchange but the marginal utility of money does not remain constant. When the consumer spends his income on the purchase of the commodity ,the amount of money left him is reduced and its marginal utility to him increases.

  • Actual price may be greater than expected price

The theory of consumer surplus that expected price is greater than the actual price. However, in real life, the actual prices are greater than expected price in the market.

  • Utility is not measurable

The law of consumer surplus is based on the assumption that utility can be measured quantitatively in the terms of money but the utility is subjective phenomenon, it cannot be measured quantitatively.

  • It is not applicable to measure necessary goods

It is not applicable to necessaries and luxurious goods. A consumer is simply willing to acquire goods. The consumer does not show any interest to get a surplus.

  • It neglects the complementary and substitutable goods

The utility of any commodity depends on other commodity but this theory does not explain the role of complementary goods and substitutable goods.

IMPORTANCE OF CONSUMER'S SURPLUS

source:www.slideshare.net
source:www.slideshare.net
  • To determine price of goods and service:

This law is very useful to determine the price of goods and services. If the consumer surplus is very high then the producer can determine high price of goods and services and vice versa.

  • To determine the tax rate:

The law of consumer surplus is useful to the government to determine the tax rate. The government can determine the high rate of tax which goods and service have more consumer surplus and vice-versa.

  • Guidelines for consumers and producer:

It can help the consumer to maximize the surplus and to maximize the profit by increasing the price of those goods which have more consumer supply.

  • Cost-benefit analysis/Project selection:

If the expected cost incurred is less and benefit is more, the project may be selected,on the other hand, if the consumer feels that they are not getting any surplus the project may not be selected.

  • International trade:

The law of consumer surplus is significant to estimate the given from the international trade. The government can produce and trade those type of goods and services in the international market which has more consumers surplus.

Bibliography

Jha, P.K., et al. Economics II. Kalimati, Kathmandu: Dreamland Publication, 2011.

Karna, Dr.Surendra Labh, Bhawani Prasad Khanal and Neelam Prasad Chaulagain. Economics. Kathmandu: Jupiter Publisher and Distributors Pvt. Ltd, 2070.

Khanal, Dr. Rajesh Keshar, et al. Economics II. Kathmandu: Januka Publication Pvt. Ltd., 2013.

  1. The concept of consumer surplus was introduced by A.J. Dupit in 1844.
  2. Alfred Marshall developed it in his book, "Principle of Economics" published in 1890.

Criticism of consumer surplus

  1. Marginal utility of money is not constant
  2. Actual price may be greater than expected price
  3. Utility is not measurable
  4. It is not applicable to measure necessary goods
  5. It neglects the complementary and substitutable goods

Importance of Consumer Surplus

  1. To determine price of goods and service
  2. To determine the tax rate
  3. Guidelines for consumers and producer
  4. Cost-benefit analysis/Project selection
  5. International trade

 

 

 

 

.

Very Short Questions

0%

DISCUSSIONS ABOUT THIS NOTE

No discussion on this note yet. Be first to comment on this note