Welcome to Kienthucykhoa.com! In this article, we will explore the concept of consumer surplus, also known as consumer surplus theory. We will delve into its definition, measurement, and assumptions. So, let’s get started!
1. What is Consumer Surplus?
Consumer surplus, also known as consumer excess or consumer surplus theory, is a measure of the economic benefit that exceeds the willingness to pay of customers. It is calculated by analyzing the difference between a consumer’s willingness to pay for a product and the actual price they have to pay, also known as the equilibrium price. Consumer surplus occurs when a consumer’s willingness to pay for a product is greater than its market price.
Consumer surplus is based on the economic theory of marginal utility, which is the additional satisfaction that an individual derives from consuming an additional unit of a product or service. The level of satisfaction varies from consumer to consumer due to differences in personal preferences. According to the theory, as consumers buy more products, they become less willing to pay more for each additional unit due to the diminishing marginal utility they receive from that product.
The concept of consumer surplus was first developed by Jules Dupuit, a French civil engineer and economist, in 1844, and popularized by the British economist Alfred Marshall. It relies on the assumption that the level of consumer satisfaction (utility) can be measured. Since utility diminishes for each additional unit purchased and prices reflect the utility of the last unit rather than the utility of all units, total utility exceeds total market value.
The importance of consumer surplus lies in providing a monetary measure of the benefit that consumers derive from the provision of a product under the conditions it is supplied. This seemingly enables the assessment of the net impact on welfare of policy changes altering the terms on which different products are supplied. Economists have used this concept to argue that some tax systems are inferior to others because they result in greater consumer surplus loss.
It is also suggested that in industries with decreasing costs, where consumer expenditure on a product will not include the total cost – if the product is sold in the market at a uniform price or, in most modern formulations, at a price equal to marginal cost – the state should create the possibility of producing the product through subsidies when the consumer surplus profit will justify this. In fact, what consumers are willing to pay but do not (or, more accurately, the state’s estimate of this) should be regarded as a complementary factor alongside what they have to pay in determining output, because it shows the more consumers bid the value of the product for them.
2. Measuring Consumer Surplus using Demand Curve:
In competitive markets for consumer goods and services, there are typically multiple producers selling those items and multiple consumers buying them. Participating in the market becomes more attractive to producers as the price they can sell their product for increases. Therefore, the quantity of the product supplied in the market increases as the price rises, and the supply curve, in general, slopes upwards. Conversely, participating in the market becomes more attractive to consumers as the price they can buy the product for decreases. Therefore, the quantity demanded increases as the price decreases, and the demand curve, in general, slopes downwards. The market equilibrium point, which includes the price p of the item and the quantity q bought and sold, is determined where supply and demand intersect, that is, where the supply curve and the demand curve intersect.
For quantities of the item less than q, consumers in the market would be willing to pay more than p. However, at the equilibrium state, they can buy and consume all q of the item at the price p per unit. The difference between the higher price they would be willing to pay for a lower quantity and the lower price they have to pay at q is the consumer surplus. It represents the value that consumers attach to the item beyond the price they have to pay for it. Consumer surplus is represented in the chart below by the shaded area below the demand curve D extending to the price level p.
The point where supply and demand meet is the equilibrium price. The region above the supply curve and below the equilibrium price is the producer surplus (PS), and the region below the demand curve and above the equilibrium price is the consumer surplus (CS).
When considering the demand curve and the supply curve, the formula for calculating consumer surplus is CS = 0.5 (base) × (height).
3. Assumptions of Consumer Surplus Theory:
Utility is a quantifiable entity: Consumer surplus theory posits that the value of marginal utility can be measured. According to economic theorist Marshall, utility can be represented as a number. For example, the utility derived from an apple is 15 units.
No substitute products: There are no available substitute products for any of the goods under consideration.
Ceteris Paribus: It assumes that the preferences, tastes, and incomes of consumers do not change.
Constant marginal utility of money: It states that the utility derived from a consumer’s income remains constant. This means that any changes in the amount of money a consumer has does not alter the utility they receive from it. It is necessary because without it, money cannot be used as a measure of utility.
Law of diminishing marginal utility: It indicates that the satisfaction derived from consuming more of a product or service decreases as the quantity consumed increases.
Marginal utility independence: The marginal utility derived from the product being consumed is not affected by the marginal utility derived from consuming similar goods or services. For example, if you drink orange juice, the utility derived from it will not be affected by the utility derived from apple juice.
4. Limitations in Consumer Surplus:
If the marginal utility of money is assumed to be constant for consumers at all income levels, and money is accepted as a measure of utility, consumer surplus can be represented as a shaded region below the consumer demand curve in the figure. If a consumer purchases MO of the commodity at prices ON or ME, then the total market value or the amount of money he spends is MONE, but the total utility is MONY. The difference between them is the shaded area NEY, which represents consumer surplus.
This concept becomes biased when economists of the 20th century recognized that the utility derived from one good is not independent of the availability and prices of other goods; besides, there are difficulties in assuming that utility can be measured accurately.
Despite these challenges, this concept is still retained by economists to describe the benefits of mass-produced goods at low prices. It is used in the fields of welfare economics and taxation. However, there are some other limitations:
It is very difficult to measure the marginal utility of different units of a commodity for an individual consumer. Therefore, it is not possible to accurately measure consumer surplus.
For essential goods, the marginal utility of a few initial units is extremely high. Thus, consumer surplus is infinite for those goods.
The availability of substitute products also affects consumer surplus.
Determining the utility scale for luxury goods such as diamonds is very difficult.
We cannot measure consumer surplus in terms of money. This is because the marginal utility of money changes as consumers make purchases and the reserve of money decreases.
This concept is only accepted with the assumption that we can measure utility in terms of money or through other means. Many modern economists disagree with this concept.
In conclusion, consumer surplus provides valuable insights into the economic benefits that consumers derive from their purchases. While it comes with some limitations and challenges, it remains a relevant and useful concept in understanding consumer behavior and welfare economics.
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