Note on Consumers Surplus

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CONSUMER SURPLUS

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

The concept of consumer surplus was introduced by A.J. Dupit in 1844. He has used his theory to measure the benefit of public project like hydro electricity & irrigation. Later on, it was further developed by Alfred Marshall in his famous book, "Principle of Economics", 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.
    When consumer goes to market to purchase goods, real price of the goods may be less than expected price. In this situation consumer is able to surplus same money & take additional benefit from surplus money which is called consumers surplus. Therefore,  consumer surplus is the difference between expected price & real price.
 i.e. CS = EP - RP
Where,
      CS = Consumer surplus
      EP = Expected Price
      RP = Real Price

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".

 

ASSUMPTIONS OFTHE LAW OF CONSUMERS SURPLUS

  • Consumers are rational.

  • No change in price.
  • Utility can be measured in cardinal number.
  • Expected price must be less than real price.

 

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

     No. of commodity

      Expected price

               Real Price

    Consumers

           Surplus

           1

            120

             60

              60

           2

             100

             60

              40

           3

             80

             60

              20

           4

              70

             60

              10

           5

              60

             60

               0

 

       EP=430

         RP=300

       C.S=130

 

In the above table, a consumer tends to assume amount which they are Expected Price (EP) but is always greater than Real Price (RP). When the consumer buys his 1st unit, then they are willing to pay 120 and the actual price 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 = EP - RP

= 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
  • Determination price of goods and service:

Determination of appropriate price of product is primary responsibility of the producer concept of consumer surplus provides basic guideline to the producer for the determination of price. Producer can determine hifh rate of price for those goods in which consumer surplus is high. Conversly, producer can determine low price for these goods in which consumer surplus is very low.

  • Formulation of Fiscal policy:

Concept of consumer surplus becomes useful for the formulation of fiscal or tax policy. Government tax officer can impose high rate of tax from those goods in which consumer surplus is also very high. Conversely, government tax officer can impose low rate of tax for the goods in which consumer surplus is very low.

  • To measure the existing degree of development:

Concept of consumer surplus provides basic guideline to measure degree of economic development in any country are in better position in which they are enjoying more consumer surplus. On the other side, people of that country are in comparatively worst condition in which consumer surolus is low.

  • Cost-benefit analysis:

First benefit analysis is the sighificant tools & techniques of planning. It is essential for project preparation & selection. If surplus or benefit is greater than cost than development project will be selected. On the other side, if benefit or surplus is low than, cost project will be rejected.

  • Distinguish between value in use & value in exchange:

Theory of consumer surplus is more useful to distinguish between vaule in ise & value in exchange. Value in use is basically related with utility whereas value in exchange is basically related with price. Some necessary goods like salt, matches, etc have greater value of use but less value of exchange. Similarly, luxurious goods have greater value of exchange & less value in use. Therefore, consumer surplus is also high for necessary goods.

 

 

 

 

 

 

 

 

 

 

 

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

 

 

 

 

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