Consumer surplus

MEANING

Sometimes a consumer feels that he is deriving more satisfaction from the consumption of a good than the amount of sacrifice he makes in money terms while getting it. This feeling in consumer's mind has been given the name of 'CONSUMER SURPLUS'.

According to Penson," The difference between what we would pay and what we have to pay is called the Consumer's Surplus.

ASSUMPTIONS

Marshall's concept of Consumer Surplus is based on certain assumptions. They are:-

1) Utility can be measured cardinally.
2) The quantity of money with a consumer does not affect the MU of money with him.
3) There is no change in income,fashion and taste of the consumer.
4) There are no substitutes of the commodity from which Consumer Surplus is being derived.
5) The concept comes true only if the law of Diminishing MU holds good.

EXPLANATION

To illustrate,  let us suppose that a consumer is willing to buy 1 orange if it's price were Rs. 1, 2 oranges if the price were 75 paise, 3 oranges at 50 praise and 4 oranges if it were 25 paise per orange.
Suppose the market price is 25 praise per orange. At this price, the consumer will buy 4 oranges and enjoy a surplus of Rs. 1.50 ( 0.75+0.50+0.25). This is shown in table below.

****draw table

The Consumer surplus can also be defined as the difference between what a consumer is willing to pay for a commodity and what he actually does pay for it. Our hypothetical consumer is prepared to pay Rs. 2.50 ( = Rs. 1.00+0.75+0.50+0.25) for 4 oranges but actually pays Rs. 1, and therefore derives a surplus of Rs. 1.50 (Rs. 2.50-1.00).

It can also be expressed as; -
                           CS= TU - MU
                                    Or
                                = Price * No. Of units of commodity
It is based on the assumptions that the price of the commodity equals it's MU.

***draw diagram

Consumer surplus is represented diagrammatically in the above figure where DD1 is the demand curve for the commodity.  If OP is the price,  OQ units of the commodity are purchased and the price paid is OP*OQ= area OQRP. But the total amount of money he is prepared to pay (TU) for OQ units is OQRD.
Therefore,  Consumer surplus= OQRD - OQRP = DRP.

If the price of the commodity falls to OP1, the Consumer surplus increases to DR1P1 and conversely a rise in price would diminish it.

MEASUREMENT OF CONSUMER SURPLUS WITH THE HELP OF INDIFFERENCE CURVE

Prof. J.R. Hicks measured Consumer Surplus assuming the cardinal measurability of utility, constancy of Marginal Utility of money and of utility being an independent entity.
According to Hicks, a fall in the price of a commodity has two main effects. These are:-
(I) With the given income consumer can now purchase more of the Good whose price has fallen;
(II) He can purchase the same quantity of that commodity as he was buying before but is left with a higher amount of money.

The fall in price spares some money income for the consumer.The money so spared is a measure of the Consumer Surplus. Prof. Hicks considered Consumer Surplus as a monetary gain to the consumer. Hicksian method of measurement of Consumer Surplus can be illustrated with the help of figure drawn below:-

****Draw diagram
The above diagram shows Commodity-A on X-axis and money income of consumer on Y-axis. We suppose that the consumer has OM amount of money income.Further, we assume that the consumer does not know the price of the commodity at present. In this situation he chooses the point R which is located on IC1 originating from point M. Here the consumer is ready to sacrifice MS amount of money for getting ON units of Commodity-A.
Now, suppose that the consumer is informed of the market price of Commodity-A which helps him in knowing his price line. In the above figure, P is a point where the price line is tangent to the higher indifference curve IC2. The point of tangency P is called the Equilibrium point. So the consumer buys ON units of Commodity-A for which he has to pay only MQ amount of money. Previously, for the same quantity of commodity he was ready to pay MS amount of money, an amount higher than the actual amount of money he now pays.
Therefore, MS - MQ = QS is the money measure of Consumer Surplus.

CRITICISMS

1) A vague idea
2) Too many assumptions
3) Applicable to a small number of cases only
4) Not applicable to highly superior and Giffen goods
5) Neglects the income effect of price change.













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