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Consumer’s surplus

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Consumer’s surplus

The law of consumer’s surplus was first developed by French engineer A.J. Dupuit in 1844 A.D, to measure the social benefits of public commodities such as canals, bridges, national highways, etc. This concept was further refined and popularized by Alfred Marshall.

According to Marshall,” Excess of the price which a consumer will be willing to pay rather than go without a thing over that which he/she actually does pay is the economic measure of this surplus satisfaction. It may be called the consumer’s surplus.”

       The amount of money which a person is prepared to pay for a commodity indicates the amount of utility that he/she derives from that commodity. Greater the amount of money he/she is willing to pay, greater the satisfaction he/she will receive.

Consumer’s surplus equals to what a consumer is prepared to pay minus what he/she actually pays.

Symbolically,

CS = TU - TE

Where;

TU= Total Utility
TE=Total expenditure

Assumptions of Consumer’s surplus

  1. The consumer should be rational.
  2. Utilities are measured in cardinal number.
  3. MU of money remains constant.
  4. The expected price should be more than the actual price.
  5. All units of the commodity should be homogeneous.
  6. Price of the commodity should remain constant.
The concept of Consumer's surplus can also be explained by the help of the following schedule:

Units
Willingness to pay (MU)
Paid amount
Consumer's surplus
1
100
25
75
2
75
25
50
3
50
25
25
4
25
25
0
TU= 250
TE= 100
CS= 150

In the above schedule, Units of commodity, marginal utility (MU) of each commodity, the actual price of each commodity and consumers surplus is shown. The marginal utility declines after consumption of each additional unit. The price of the commodity remains constant. Actual price is subtracted from marginal utility to get consumers surplus. The total utility obtained is 250 with a total paid 100. The overall consumer’s surplus is 150. It can be also presented in the following diagram.

Consumer’s surplus
In the above figure, quantity is measured along x-axis and price or MU is measured along y-axis. DD1 is the MU curve for the commodity. At OP price, OQ units of a commodity are purchased and the price paid is OP × PQ. This is equal to the area OPRQ. But the total amount of money he is prepared to pay is OD for OQ quantity. This is equal to the area ODRQ. The consumer's surplus, therefore it is equal to ODRQ -OPRQ is equal to PDR.

Criticisms of consumer's surplus

  1. Imaginary
Under the consumer's surplus, we just imagine that we are prepared to pay and subtract what we actually pay. It is all hypothetical.
  1. The utility is not measurable
      Since utility is a subjective concept, it cannot be measured quantitatively.
  1. MU of money never remains constant
While calculating consumer’s surplus, we do not take into consideration the change in the marginal utility of money which keeps on changing.
  1. Not applicable to necessaries
In the case of necessary goods, the utility derived is immeasurable. The price of necessaries may be low but the utility derived from them is very high.
  1. Neglects complementary commodities
The utility of a commodity x is dependent not only on its supply but also on the supply of related commodity y. Marshall ignores this relation.
  1. Neglects substitutes
The satisfaction that the consumer derives from one commodity is also dependent upon its substitute. This relation is also ignored by Marshall.

Importance of consumer’s surplus

  1. In public finance
It is useful to the finance minister in imposing taxes and fixing their rates. He/she will tax those commodities in which the consumer enjoys much surplus.
  1. To the business person and monopolist
It is important to the business person and monopolist to fix the price for those goods which give maximum satisfaction to the consumer.
  1. Comparing the advantages of different places
It is useful to compare the benefits that we obtain from different places. For example; more satisfaction can be obtained on consumers' lives in a developed area than underdeveloped areas.
  1. Measuring benefits from international trade
We can measure the benefits of international trade with the idea of consumer’s surplus. Suppose that before entering into the trade with another country, we are prepared to pay Rs 45000 for a computer. But after establishing the relation of trade, we get it for Rs 30000. The difference between the prices is the consumer’s surplus which measures the benefit from international trade.
  1. The distinction between value in use and value in exchange
The concept of consumer’s surplus helps us to distinguish between value in use and value in exchange. Value in use means utility and value in exchange mean the price of a commodity. Commodities like salt, postcard, matchbox, etc have a great value in use but the small value in exchange.

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