If you enter Walmart to buy a pack of hot Cheetos, you most likely want your money's worth at least. You would like to be better off after purchasing that pack of hot Cheetos. So, how do we know whether you're better off? We look at your consumer surplus, which is the benefit you get from consuming a good. But how does it work? Well, as you felt like buying that pack of hot Cheetos, you had an idea how much you would be willing to spend on it. Your consumer surplus is the difference between how much you were willing to purchase the item for and how much you actually purchased it for. Now, you've heard a bit about your consumer surplus, and you're hooked. Want to learn more? Read on!
Consumer Surplus Definition
The main reason why consumers buy products is that it makes them better off. So, we could simplify the definition of consumer surplus as how much better off consumers are as they make a purchase. Realistically, different people could value their consumption of the same product differently. Simply put, while one person may want to pay a given price for a good, another person may want to pay more or less for the same good. Therefore, the consumer surplus is the value or benefit a consumer gains from purchasing a product in the market.
The consumer surplus is the benefit a consumer gains from purchasing a product in the market.
Or
The consumer surplus is the difference between how much a consumer is willing to pay for a product and how much the consumer actually pays for the product.
You may have noticed that we keep mentioning willingness to pay. What is that about? Willingness to pay simply refers to the maximum amount a consumer would purchase a good for. It is the value that a consumer places on a given good.
Willingness to pay is the maximum amount a consumer would pay for a good and is a measure of how much a consumer values a given good.
Consumer Surplus Graph
The consumer surplus graph can be illustrated using the demand curve. Here, we plot the price on the vertical axis, and the quantity demanded on the horizontal axis. Let's look at the consumer surplus graph in Figure 1, so we can continue from there.
Fig. 1 - Consumer surplus graph
As shown in Figure 1, the consumer surplus is the area above the price and below the demand curve. This is because the demand curve represents the demand schedule, which is the price of the good at each quantity. Consumers are willing to pay anything within the demand schedule until point A, and since they are paying P1, they get to keep the difference between point A and P1.
The consumer surplus graph is the graphical illustration of the difference between what consumers are willing to pay and what they actually pay.
Now, consider an example where the price of a good in the market reduces from P1 to P2.
In the above example, the consumer surplus graph is as shown in Figure 2.
Fig. 2 - Consumer surplus with a price decrease
As shown in Figure 2, the triangle ABC represents the consumer surplus of all consumers who bought the product at P1. When the price reduces to P2, the consumer surplus of all the initial consumers now becomes the area of triangle ADF. Triangle ADF is the initial surplus of ABC with the additional surplus of BCFD. For new consumers who joined the market at the new price, the consumer surplus is triangle CEF.
Read our article on the Demand Curve to learn more about the demand curve!
Consumer Surplus Formula
To derive the formula for consumer surplus, the consumer surplus graph provides a vital clue. Let's look at the consumer surplus graph in Figure 3 below to help us derive the formula.
Fig. 3 - Consumer surplus graph
As you can see, the area shaded as the consumer surplus is a triangle ABC. This means that to calculate the consumer surplus, we simply need to find the area of that triangle. How do we do this?
We use the following formula:
\(Consumer\ surplus=\frac{1}{2}\times\ Q\times\ \Delta\ P\)
Where Q represents the quantity demanded and P is the price of the good. Note that the change in price here represents the maximum consumers are willing to pay minus the actual price of the good.
Let's try an example now!
Amy is willing to buy a piece of cake for $5, whereas a cake sells for $3 a piece.
What is Amy's consumer surplus if she buys 2 pieces of cake?
Using:
\(Consumer\ surplus=\frac{1}{2}\times\ Q\times\ \Delta\ P\)
We have:
\(Consumer\ surplus=\frac{1}{2}\times\ 2\times\ (\$5-\$3)\)
\(Consumer\ surplus=$2\)
Here's another example.
There are 4 consumers in the market who are all interested in buying a cake. If the cake sells for $90 a piece, none of the consumers buy a cake. If the cake sells for anywhere between $70 and $90, only 1 consumer is willing to buy a piece. If it sells for anywhere between $60 and $70, two consumers are willing to buy a piece each. For anywhere between $40 and $60, 3 consumers are willing to buy a piece each. Finally, all 4 consumers are willing to buy a piece each if the price is $40 or below. Let's find the consumer surplus is the price of a piece of cake is $60.
Let's illustrate the demand schedule for the above example in Table 1 and Figure 4.
| Consumerswilling to buy | Price | Quantitydemanded |
| None | $90 or above | 0 |
| 1 | $70 to $90 | 1 |
| 1, 2 | $60 to $70 | 2 |
| 1, 2, 3 | $40 to $60 | 3 |
| 1, 2, 3, 4 | $40 or below | 4 |
Table 1. Market demand schedule
Based on Table 1, we can then draw Figure 4, as shown below.
Fig. 4 - Market consumer surplus graph
We have used steps here to simplify things, but a typical market demand curve has a smooth slope because there are many consumers, and a small change in the number of consumers isn't so obvious.
To determine the market consumer surplus, we look at the consumer surplus at each quantity and price. The first consumer has a surplus of $30 because they were willing to buy a piece of cake for $90 but got it for $60. The consumer surplus for the second consumer is $10 because they were willing to buy a piece of cake for $70 but got it for $60. The third buyer is willing to pay $60, but as the price is $60, they get no consumer surplus, and the fourth buyer cannot afford a piece of cake.
Based on the above, the market consumer surplus is:
\(\hbox{Market consumer surplus}=\$30+\$10=\$40\)
Consumer Surplus vs. Producer Surplus
What is the difference between consumer surplus vs. producer surplus? You must be thinking, if consumers have a surplus, then surely producers have one too. Yep, they do!
So, what is the difference between the consumer surplus and the producer surplus? The consumer surplus is the benefit of consumers when they purchase a good, whereas the producer surplus is the benefit of producers when they sell a good. In other words, the consumer surplus is the difference between how much the consumer is willing to pay for a good and how much is actually paid, whereas the producer surplus is the difference between how much a producer is willing to sell a good for and how much it actually sells for.
- The consumer surplus is the difference between how much the consumer is willing to pay for a good and how much is actually paid, whereas the producer surplus is the difference between how much a producer is willing to sell a good for and how much it actually sells for.
Just like the consumer surplus, the formula for the producer surplus is also as follows:
\(Producer\ surplus=\frac{1}{2}\times\ Q\times\ \Delta\ P\)
However, in this case, the change in price is the actual price of the product minus how much the producer is willing to sell it for.
So, let's summarize the main differences here:
- The consumer surplus uses willingness to pay, whereas the producer surplus uses willingness to sell.
- The producer surplus subtracts how much the producer is willing to sell an item for from the actual price, whereas the consumer surplus subtracts the actual price from how much the consumer is willing to pay.
Interested in learning more?We've got you covered!Click on Producer Surplus to dive in!
Consumer Surplus Example
Now, let's look at a simple example of consumer surplus.
Ollie is willing to pay $60 for a purse but actually gets to buy it for $40 when her friend joins her in buying it.
They end up buying a purse each.
What is Ollie's consumer surplus?
We use the formula:
\(Consumer\ surplus=\frac{1}{2}\times\ Q\times\ \Delta\ P\)
So, we have:
\(Consumer\ surplus=\frac{1}{2}\times\ 1\times\ ($60-$40)\)
\(Consumer\ surplus=\frac{1}{2}\times\ $20\)
\(Consumer\ surplus=$10\)
Read our article on Market Efficiency to broaden your knowledge about the consumer surplus!
Consumer Surplus - Key takeaways
- The consumer surplus is the difference between how much a consumer is willing to pay for a product and how much the consumer actually pays for the product.
- The consumer surplus graph is the graphical illustration of the difference between what consumers are willing to pay and what they actually pay.
- The formula for the consumer surplus is:\(Consumer\ surplus=\frac{1}{2}\times\ Q\times\ \Delta\ P\)
- The producer surplus is the difference between how much a producer is willing to sell a good for and how much it actually sells for.
- The consumer surplus is the benefit of consumers when they purchase a good, whereas the producer surplus is the benefit of producers when they sell a good.
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