Consumer Surplus

The consumer surplus refers to the net benefit a consumer gains from purchasing a good. Also known as the consumer's surplus, it's the difference between the maximum price a consumer is willing to pay for a unit of the good (called the reservation price) and the actual market price paid.

For example, if a consumer is willing to pay 100 (P_max) for a unit of a good but buys it at the market price of 80 (P_e), they gain an initial surplus of 20.

In economics, consumer surplus is shown as the area between the demand curve of the good and the line indicating its market price.

Marshall defines consumer surplus as the psychological gain a consumer enjoys because, for initial units of consumption (Q), they are willing to pay a price above the market rate. Thus, consumer surplus is the difference between the highest price a consumer is willing to pay for an extra unit (demand price) and the actual market price. A rational consumer buys quantities of the good that allow them to equalize the demand price with the market price. The consumer surplus is at its peak with the first units consumed. On a graph, this maximum surplus is represented by the segment P_max - P_e on the vertical axis. As more units of the same good are purchased, the scarcity diminishes, lowering the reservation price the consumer is willing to pay for additional units. This explains the downward slope of the demand curve as consumption rises. On the other hand, the market price is set by supply and demand forces at the equilibrium point (point E). At market equilibrium, the consumer buys Q units at price P_e, with a total expenditure of Q x P_e.

Calculating Consumer Surplus. In a graph, total spending is shown by the rectangle OP_eEQ (area B + C), while the total welfare experienced by the consumer is represented by the area OP_maxEQ (area A + B + C). The total welfare area (A + B + C) also shows the maximum amount the consumer would pay for Q units of the good. As the graph illustrates, the total welfare area (A + B + C) is greater than the area representing actual spending (area B + C). The difference between these areas is the overall consumer surplus (area A). As the price decreases from P_max toward E along the demand curve, the gap between the maximum reservation price P_max and the market price P_e narrows, while the consumer surplus area expands, reflecting the additional net benefit the consumer receives.

Total Surplus. Total surplus is the sum of consumer surplus (A) and producer surplus (B). In the previous diagram, total surplus is represented by the area (A + B), which reflects the combined value and welfare gained by consumers and producers from producing and trading Q units of the good at market price P_e.