The term Surplus refers to additional or extra. Before making any buying decision, a consumer assumes the cost of that product. When the assumed cost is lesser than the cost he has to pay, he is benefitted from the difference between assumed product cost and actual product cost.
This is known as Consumer Surplus.
For example – Adam estimates that the price of his pocket perfume is around $15 but the shopkeeper quoted him a perfume price of $8.
Therefore, he saved $7 here, in terms of surplus, which can be utilized for his other goods.
Consumer Surplus shows monetary gain which consumers can yield beyond their income. He is getting more benefits by paying a lesser amount for the same goods.
He can either save the amount or allocate it to the product which is not priced in his budget.
How to measure Consumer Surplus?
Let us understand the measurement of consumer Surplus with the example below-
As we know, the price of a good and demand for that good share inverse relations. When the price of a product increases, its demand decreases.
Now, assuming that consumer A is willing to purchase goods at $100 but he is getting that good at a meagre $30. So, his additional monetary benefit is $100-$30=$70.
Similarly, consumer B assumes that the price of a good shall be $50 but he also gets it at $30. Again, his monetary gain is $20.
Another consumer C estimates the price of the same good at $120 but he also gets it at $30, benefitting him $90.
All the Surplus taken together shows aggregate consumers’ Surplus. This concept is, sometimes, also used to ensure social benefit and consumers’ welfare.
Consumer Surplus and Marginal Utility
Consumer Surplus is based on the concept of Marginal Utility.
But, what is Marginal Utility?
The utility is derived from the work “utils”.
Utils refers to the unit which measures the satisfaction level of consumers.
Therefore, utility is the want satisfying power of any good or service consumed by consumers.
For example: When a child eats noodles, he takes a full bowl for the first time to fulfill his appetite.
When his appetite demands more, he refills his bowl with noodles but this time the quantity is lesser than before. It shows his desire is lesser than before.
The third time, the child again arrives with the empty bowl but takes not more than two spoons of noodles because his desire is no longer as high as the first time.
The fourth time, his desire to take more ends.
This example shows that the satisfaction derived from every additional unit consumed decreases.
Let us now understand the relationship between consumer Surplus and marginal utility with the table below :
|Price||Units||Total Utility||Marginal Utility||Consumer Surplus|
Marginal Utility and Consumer Surplus
Keeping the price of the product constant, we see that as the units are additionally consumed, the Marginal utility derived from every additional unit tends to decrease.
When a consumer consumes 2 units his MU is equivalent to 15 utils, when he consumes 3 units his MU drops down to 13 utils, and so on.
TU refers to the total utility which is the total of all the utils consumed from all the units taken together.
Again, assuming 1 util = $1
When the consumer consumes additional 15 utils he is paying only $10 for that.
This means his Surplus is 15-10=$5
With decreasing utils, his Surplus also decreases, and finally, his Surplus stops.
This is the point where he is not gaining any monetary Surplus.
In the nutshell, Consumer Surplus refers to the benefits which consumers gain when the market price of goods is lesser than the price they are willing to pay. Although the utility derived by the different consumers from the same product is different yet, it is budget-friendly for many of them.
The Surplus ends when a consumer reaches a point of Satiety. This is the point when marginal utility is Zero and total utility is at its maximum.
Consumer Surplus can also be negative when the price consumer is willing to pay is less than what he actually has to pay!