Consumer Surplus Definition
Graph and Example
WRITTEN BY PAUL BOYCE | Updated 6 September 2020
What is a Consumer Surplus
A consumer surplus is defined as the gap between what consumers are able and willing to pay, and the actual price paid. In other words, if the consumer is willing to spend $5 on a Dunkin’ Donut, but they only pay $3 for it, the consumer surplus is the gap between what they are willing to pay ($5) and what they actually pay ($3). In this case, it would be $2.
It measures the extra benefit the consumer receives over and above what they would be willing to pay. So when the consumer pays less than they would be willing to pay – the difference is considered as the consumer surplus.
- The consumer surplus is the gap between what the consumer is willing to pay and what they actually pay.
- If the consumer is willing to pay $5 for a good, but pays $3 – the consumer surplus is the difference which is $2.
We can measure the consumer surplus by calculating the area where supply and demand align. As we can see from the graph below, this occurs where P1 aligns with Q1 – the area above refers to the consumer surplus. The area below the curve refers to the producer surplus.
Consumer surplus is linked to marginal utility – the additional satisfaction that the consumer receives from consuming an additional good or service. When marginal utility falls to zero, it means that the consumer will no longer be willing to purchase the good or service. This is also at the point where there is no longer a consumer surplus.
How to Calculate Consumer Surplus
Before we calculate consumer surplus, we must first make one clarification. On an individual level, consumer surplus refers to the difference between what the consumer is willing and able to pay, and what they actually pay. This is worked out using the formula below:
Consumer surplus = maximum price willing to pay – actual price
Looking at the chart, this just looks at the price difference without considering the overall supply and demand of the product. In other words, it doesn’t look at the wider economy.
So when calculating consumer demand, we are referring to the overall consumer surplus, not just on an individual basis. To explain, we are looking at the total shaded area, rather than just the vertical line.
To calculate consumer surplus, let us take an example.
Example of Consumer Surplus
Let’s say there are doughnuts on sale for $3. In turn, 1,000 are sold at that price. The maximum any one consumer would pay is $6. This willingness to pay starts to decline along the demand curve until it reaches supply.
The area of the consumer surplus is the triangle above this line. In turn, we can capture the surplus of all consumers. We do so by working out the area of this triangle,
In this case, it would be 1,000 (quantity sold) x ($6 (the maximum willingness to pay) – $3 (actual price) x 0.5 (as it’s a triangle) = 1,000 x 3 x 0.5 = 1,500.
Consumer and Producer Surplus
A consumer surplus refers to the difference between the maximum a consumer would be willing to pay, versus the actual market price. The producer surplus contrasts with this. It refers to the minimum a producer would be willing to sell for and the amount it actually sells at. In other words, it is just a fancy word for profit.
The producer surplus can be calculated using the formula:
Total revenue – total cost = producer surplus
Importance of Consumer Surplus
The consumer surplus refers to the utility that consumers receive. In other words, people are willing and able to pay more, so obtain utility from making the transaction. This is because they value the good more highly than what they actually pay.
If their willingness to pay is less than the price of the product, then the transaction does not take place. So whenever a product is brought, there is a consumer surplus.
This is important because every transaction has a consumer surplus. However, those whose maximum willingness to pay is the same as what they pay; do not create a consumer surplus.
With that said, consumer surplus is important because not all consumers will purchase the product. Those with a large surplus will come back and buy again. This is because the price they pay is much lower than what they value the product.
On the surface, it may seem like businesses would want to get rid of the consumer surplus. After all, the business is losing out on potential profits. In part, this is what some businesses do through various forms of price discrimination. However, this isn’t always feasible.
In such situations, consumer surplus can be seen as a good thing, because consumers will keep coming back as they receive a greater benefit than they pay.
The consumer surplus is the area above where price meets supply or demand.
The consumer surplus is a good thing because it indicates that consumers are happy to purchase the product. If there was no consumer surplus, the consumer would receive no utility from purchasing the good or service. Therefore, a transaction would not take place.
A consumer surplus is defined as the gap between what consumers are able and willing to pay, and the actual price paid.