Introduction to Consumer Surplus

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What Is Consumer Surplus?

Paying has never been easier Shot of a customer paying for their order with a debit machine in a cafe
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Economists are quick to point out that markets create economic value for both producers and consumers. Producers get value when they can sell goods and services at prices higher than their costs of production, and consumers get value when they can buy goods and services at prices less than how much they actually value said goods and services. This latter type of value represents the concept of consumer surplus.

In order to calculate consumer surplus, we need to define a concept called willingness to pay. A consumer's willingness to pay (WTP) for an item is the maximum amount that she would pay. Therefore, willingness to pay amounts to a dollar representation of how much utility or value an individual gets from an item. (For example, if a consumer would pay a maximum of $10 for an item, it must be the case that this consumer gets $10 of benefits from consuming the item.)

Interestingly enough, the demand curve represents the willingness to pay of the marginal consumer. For example, if demand for an item is 3 unit at a price of $15, we can infer that the third consumer values the item at $15 and thus has a willingness to pay of $15.

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Willingness to Pay Versus Price

As long as there is no price discrimination present, a good or service is sold to all consumers at the same price, and this price is determined by the equilibrium of supply and demand. Because some customers value goods more than others (and hence have higher willingness to pay), most consumers don't end up getting charged their full willingness to pay.

The difference between consumers' willingness to pay and the price that they actually pay is referred to as consumer surplus since it represents the "extra" benefits that consumers get from an item in excess of the price that they pay to get the item.

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Consumer Surplus and the Demand Curve

Consumer surplus can be represented pretty easily on a supply and demand graph. Since the demand curve represents the marginal consumer's willingness to pay, consumer surplus is represented by the area underneath the demand curve, above the horizontal line at the price that consumers pay for the item, and to the left of the quantity of the item that is bought and sold. (This is simply because consumer surplus is zero by definition for units of a good that don't get bought and sold.)

If the price of an item is measured in dollars, consumer surplus has units of dollars as well. (This would obviously be true for any currency.) This is because price is measured in dollars (or other currency) per unit, and quantity is measured in units. Therefore, when dimensions are multiplied together to calculate area, we are left with units of dollars.