Lecture-17 Consumer's Surplus

Lecture-17
Consumers Surplus
Learning objective: concept of consumer surplus, Measurements of consumers
surplus(Marshallian approach and Hicksian approach) and importance of
consumer surplus
The concept of consumers surplus was first of all evolved by Dr Alfred Marshall.
According to him consumer surplus is Excess of price which a consumer
would be willing to pay, rather than go without a thing over that which he
actually does pay.
The amount of money which a person is prepared to pay for good indicate the
amount of utility he derives from that good, the greater the amount of money he is
willing to pay, greater the utility he will obtain the good. Therefore the marginal
utility of a unit of a good determines the price a consumer will be prepared to pay
for that unit.
The total utility will get from a good will be given by the sum of marginal utilities
of the units of good purchased and the total price which he actually pay is equal to
the price per unit multiplied by the number of units purchased, thus,
Consumer Surplus =what a consumer is prepared to pay minus what he actually
pays
=Sum of marginal utilities _ (price X No. of units purchased)
Measurements of consumers surplus:
There are two approaches to measure the consumer surplus;
i)
Marshallian approach
ii)
Hicksian approach
Marshallian approach:
This approach is based on cardinal utility approach. The concept is based on the
difference between total utility and marginal utility. A will stop buying a
commodity at a point where the sacrifice made by him in terms of the price of
the commodity is equal to its marginal utility.
Assumptions: Concept of consumers surplus is based on the following assumptions.
a. Utility can be measured in cardinal numbers
b. Marginal utility of money remains constant and utility of a commodity

can be expressed in terms of money.
c. Every commodity is an independent commodity or it has no substitute. It
means utility of a commodity is not influenced by the utility of another
commodity.
d. Income, fashion, custom, taste etc. of the consumer remains constant.
e. Concept of consumers surplus is based on demand curve or marginal
utility. Thus all the assumptions of demand curve also apply to this
concept.
Explanation:
The concept of consumers surplus can be explained with the help of following table
and figure.
Units of a good
MU/ Price
Actual price
Consumers
surplus
First unit
50
25
25
Second unit
40
25
15
Third unit
35
25
10
Fourth unit
25
25
0
Total
150
100
50
From this table it can be seen that
Total utility = 50+40+35+25 =150
Price or marginal utility sacrificed =25X4 =100
Consumers surplus = 150-100 =50.
In figure below in which number of units of good X are shown on X-axis and price on Yaxis. The consumer is willing to pay 50 paisa for the first unit of good X and 40 for the
second unit and so on. Hence he is willing to pay OABCD price, however, he actually
pays OPCD price. Hence area equal to ABCP is consumers surplus.
Hicksian Concept of Consumers Surplus: Prof Hicks has attempted to measure

consumers surplus with the help of ordinal utility (indifference curves). It is illustrated as
below in the figure.
In the figure, units of good X are shown on X-axis and money income of the
consumer on Y-axis. Suppose the income of the consumer is OM. With this
money he can buy ON units of good X, therefore MN is the price line. Slope of
price line OM/ ON expresses the price per unit. Price line is tangent to IC2 at E
i.e. consumer is at equilibrium.
He buys OQ units of good X by paying MA units of money.
Supposing the consumer does not know the price prevailing in the market. In
order to get OQ units of good X the price he would be willing to pay can be
ascertained from indifference curveIC1 touching point M. It is evident from
the indifference curve IC1 that to buy OQ units of good X the consumer is
willing to pay MB units of money, whereas he does actually pay MA units of
money income. Thus the consumer is getting a surplus of (MB-MA) equal to
AB amount of money.
Importance of consumers surplus concept: The concept of consumers surplus has
both theoretical as well as practical importance.
1. Conjectural Advantages
The concept enables us to compare the advantages of environment and
opportunities or conjectural benefits. The conjectural benefits derived by people
enable us to compare the standards of living in different parts of the world. If
consumers surplus is more in any country, then living standards of the people are
high and vice versa. For example, the living standards of the people of USA or
Japan is certainly more when compared to India because in those countries the
national output, national income and per capita income of the people are high
Thus, it helps to measure the volume of economic welfare of the people who live
in different parts of the world.
2. Use in cost benefit analysis
Today the concept is extensively used in estimating the cost benefits of various
investment projects both in the private and public sectors. Costs and benefits do
not merely mean money costs and monetary benefits but also real costs and real
benefits in terms of satisfaction and the amount of resource utilization. The
quantum of consumers surplus derived from social projects like railways, roads,
bridges, dams, flyovers, parks, libraries, water and electricity supply etc by
consumers are definitely higher when compared to the amount of money spent on
them. For example, a consumer would pay a very little amount of money to travel
in a public transport vehicle than what he has to pay if he were to travel in an
auto-rickshaw or taxi. The cost savings from these projects are directly derived
from consumers surplus.
3. Use in public Finance

It is the basis to impose taxes on people. If consumers surplus is high in case of
any product or service, then the finance minister can impose higher taxes on them
and vice versa. This is because people are ready to pay more prices for such
products rather than go without them. It is the basis to declare whether taxation
policy of a government is good or bad. If the gain to the government on account
of tax collection is greater than the losses to the consumers on account of tax
payment, it is a good taxation policy and vice versa.
In this case, the total tax amount collected by the government is greater than that
of the total amount of sacrifice made by the people on account of tax payments.
It is the basis to grant subsidy by the government to private entrepreneurs. If the
amount of gain to the people on account of subsidy is greater than the financial
loss to the government owing to the grant of subsidy, we can justify such subsidy
and vice versa. For example, if government grants subsidy to sugar, market
price of sugar declines and consequently, more consumers would buy more
quantity of sugar and enjoy greater amount of satisfaction.
4. Pricing of public utilities.
The concept helps in determining prices of public utilities. In case of construction
of railway lines, air ports, roads, bridges, generation and supply of electricity,
water supply etc, and people enjoy enormous amount of surplus satisfaction.
While fixing the prices of these services, or commodities, the government does
not look into its production and supply cost. As they are public utilities, the
government follows the policy of price discrimination.
5. Helps to resolve the paradox of value
Generally speaking market value of product depends on its demand and supply. In
case of certain essential commodities like water etc supply will be more and as
such its market price will be low. In these cases, marginal utility will be low
whatever may be the value of total utility.
In case, there is scarcity of a product in the market, its price would go up. In this
case, marginal utility will be high whatever may be value of total utility.
Commodities which have more value in use give more satisfaction than others
which have more value in exchange. For example, in case of salt, match box,
news paper etc total utility is more but marginal utility is less and as such we pay
much less money for them. Value in use in case of such goods is much higher than
their value in exchange.
Commodities which have more value in exchange give less satisfaction than
others which have more value in use. For example, in case of diamond, value in
exchange is more than value in use because in these cases, marginal utility is
higher than total utility. Thus, the concept helps to distinguish between value in
use and value in exchange.
6. Use monopoly Pricing
It helps the monopolist to practice price discrimination. If consumers surplus is
high, in case of any commodity or service, then the monopolist can charge higher
prices and vice versa.
7. Use in international Trade
It is the basis to import certain items from other countries. If consumers surplus is
more in case of imported goods than domestically manufactured goods, in that
case it is better to import.
Similarly, if consumers surplus is low with in the country and high in other
nations, in that case, it is better to export them to other nations.
8. Use in welfare Economics
It is used as a tool in welfare economics. The doctrine emphasis the advantages
derived due to a fall in the prices of the commodities.

Fall in price leads to rise in the real income of the consumer and this will
definitely raise the level of welfare of the people, the level of economic well
being of the people is higher in those countries.

According to Dr. Little, the government should adopt those economic policies
which promote consumers surplus. Such policies will certainly help to increase
the economic welfare of the people to the maximum extent.
9. Use in introduction of new products
If consumers surplus is greater in the case of introduction of a new product than
the disappearance of the old product, we can justify the introduction of a new
product into the market. This helps the consumers to maximize their satisfaction.
Thus the concept of consumers surplus has great practical application in all most
all fields of economic activities.
Questions
1 The concept of consumers surplus was first of all evolved by
a) Dr Alfred Marshall
b) Adam Smith
c) A Koutsoyannis
d) All of the above
2. The concept of consumer surplus helps a monopolist firm:
a) To levy high prices
b) To levy low prices
c) To choose prices under Govt directives
d) None of the above
3. Commodities having higher consumer surplus have
a) Large value in use
b) Low value in use
c) Both a and b
d) All of the above
4. Commodities which have more value in exchange give
a) More satisfaction than others which have less value in use
b) Less satisfaction than others which have more value in use
c) Both a and b
d) All of the above
5 The price which a consumer is willing to pay and what he actually pays is
a) Producers surplus
b) Consumers surplus
c) Both a and b
d) None of the above
Answers
1a)
2 c)
3 a)
4 b)
5 b)

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Lecture-17

b. Marginal utility of money remains constant and utility of a commodity

Hicksian Concept of Consumers Surplus: Prof Hicks has attempted to measure

3. Use in public Finance

derived due to a fall in the prices of the commodities.

being of the people is higher in those countries.

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