Meaning of Consumer’s Surplus:
Consumer’s Surplus is one of the most important concepts in Economics. It was expounded by Alfred Marshall. It needs careful study.
In our daily expenditure, we often find that the price we pay for a commodity is usually less than the satisfaction we derive from its consumption.
In our own mind, sometimes we are prepared to pay much more for a commodity than we actually have to pay. People are often heard saying, “i would have paid much more for it rather than go without it.” This means that he has made a saving or derived extra satisfaction over and above the money he has paid.
In some cases, the idea 0f consumer s surprise is quite obvious, e.g., a packet of salt, a post-card, a newspaper, a match-box, etc. These things are very useful, but they are also very cheap. We are, therefore, prepared to pay much more for them, if need be, than we actually have to pay. From their purchase, therefore, we derive a good deal of surplus or extra satisfaction over and above the price that we pay for them. This is consumer’s surplus.
Consumer’s surplus is the excess of what we are prepared to pay over what we actually pay for a commodity. It is the difference between what we are prepared to pay and what we actually pay. Thus, Consumer’s surplus = what one is prepared to pay minus what one actually pays.
We can put it in the form of an equation thus:
Consumer’s Surplus = Total Utility – Total Amount Spent.
We can illustrate the concept of consumer’s surplus with the help of the table given below:
It is assumed in the above table that the price of oranges in the market is 50 P per orange. The consumer will purchase as many oranges as make his marginal utility equal to the price. Thus he will purchase 5 oranges and pay for each 50 P. In this way he will spend in all Rs. 2.50P. But the total utility of the 5 organs is equal to 690 P He thus gets a consumer’s surplus equal to (690 – 250) =440P.
The consumer’s surplus can also be found from the fourth column of the table. The utility of the first unit of oranges to the consumer is equal to 200 P.; therefore he would be prepared to pay 200 P. for it rather than go without it. But he pays for the first orange only 50 p. because the price of an orange in the market is 50 p.
Therefore, from the first unit, the consumer gets consumer’s surplus equal to (200 —50) = 150P, which is written m the fourth column. Similarly, the utility of the second orange is equal to ISO, while the consumer pays 50P. For it and therefore obtains (180 — 50) = 130P. as consumer’s surplus. From the fifth unit the consumer derives satisfaction equal to 50 and he also pays 50P for it. Thus there is no consumer’s surplus from the fifth unit. Now if we add the figures in the 4th column, we shall get the total consumer’s surplus equal to 440P.
We can represent consumer surplus with the help of the following diagram. Along OX are measured the units of the Commodity and along OY is measured Marginal utility in terms of money, which means the price that the consumers willing to pay, rather than go without a particular unit of the commodity.
If the market price is PM, the consumer will extend his purchase up to the Mth unit: That is, he will purchase OM quantity. This is so because for this amount his marginal utility is equal to the price. But his marginal utility for the earlier units is more than PM. For M ‘th unit, for instance, his marginal utility is P’M’, but he only pays the market price PM (= P”M’) for this unit as for others. He thus obtains an excess of utility for the M ‘th unit equal to P’P”. This is consumer’s surplus from this unit.
Similar surplus arises from the purchase of other units. The total consumer’s surplus thus derived by him when OM units are purchased at PM Price is shown by the shaded area UAP. If the market price rises to ‘M’ he will purchase only OM’ quantity and the consumer’s surplus will fall to the smaller triangle UA ‘ P’.
Can Consumer’s Surplus be Measured?
It looks as if consumer’s surplus can be measured. The measurement of consumer’s surplus, however, is not as simple as that. There are numerous difficulties which stand in the way of the precise measurement of consumer’s surplus, e.g.,
(i) A Complete list of demand prices is not available:
We are aware only of a part of the demand schedule. What we may be prepared to pay for certain units is all a guess-work.
(ii) Consumer’s surplus in the case of necessaries of life and conventional necessaries is indefinite and immeasurable.
(iii) The incomes of the consumers differ:
Some consumers are rich, while others are poor. They all pay the same price. Thus, the poor consumer makes a greater sacrifice to get a commodity. This difference in the consumer’s circumstances makes the measurement of consumer’s surplus difficult and inexact.
(iv) Consumers differ in sensibilities:
Every consumer has his own tastes and sensibilities, and is therefore prepared to offer different amounts for the same commodities.
(v) Marginal utility of money changes:
As we go on buying a commodity, less and less amount of money is left with us. Hence marginal utility of each unit of money increases with every successive purchase of a commodity. If we ignore this change in the utility of money, our calculations of the consumer’s surplus cannot be scientifically accurate.
(vi) The utility of the earlier units of a commodity decreases and this decrease is not taken into account when calculating the consumer’s surplus.
(vii) Then, there is the difficulty arising out of the presence of substitutes. If there were no tea, the utility of coffee would have been much greater, and vice versa.
We may conclude by admitting that the exact measurement of consumer’s surplus in a market is impossibility. But on that account we cannot say that the concept of consumer’s surplus is of no value. We can have some estimate of consumer’s surplus, rough as it may be. Even this is of very great practical value.
Rehabilitation of the surplus by Hicks: Concept of Consumer’s:
It may also be added that Prof. J.R. Hicks has given a solution of the difficulty arising out of the immeasurability of utility and has thus rehabilitated the doctrine of consumer’s surplus. He approaches it in terms of ordinal utility function or indifference curve technique. He has given a measure of consumer’s surplus without assuming utility to be measurable and marginal utility of money to be constant.
Criticism of Consumer’s Surplus:
The concept of consumer’s surplus has been criticized on several grounds:
It is said that this is a purely imaginary idea. You just imagine what you are prepared to pay and you proceed to deduct from that what you actually pay. It is all hypothetical. One may say that one is prepared to pay anything. Hence it is unreal.
Difficult to Measure:
It is difficult to measure consumer’s surplus exactly. Few can say what they would be prepared to pay for a thing. Besides, different people are prepared to pay different amounts. It would be a hopeless task to put down how much each individual would be willing to pay. Hence the total consumer’s surplus in the market cannot be measured.
It is pointed out that if the consumer knew that any such thing existed, he would go on buying more and more till the surplus utility he enjoyed disappeared. This is wrong. A consumer does not run after a surplus yielded by one commodity. He has to weigh the utilities of other commodities too.
Not Applicable to Necessaries:
The idea of consumer’s surplus does not apply to the necessaries of life or conventional necessaries. In such cases the surplus is immeasurable. What would not a man be prepared to pay for a glass of water when he is dying of thirst?
Dr. Marshall has given a detailed reply to all these points of criticism. He points out that the concept is not as unreal as it is supposed to be. A man living in a city enjoys many amenities at low prices. If a man living in a distant village were keen to enjoy them, he would have to spend much more.
Thus a man earning Rs. 1000 per mensem in city derives greater satisfaction from its outlay than a man having the same income in some remote village. The man in the city enjoys a consumer’s surplus, because he can have more things and at lower prices.
The Marshallian measure of consumer’s surplus has been severely criticised. A very serious objection against the Marshallian measure of consumer’s surplus with the help of demand curve (or marginal utility curve) is that it is based on the twin assumptions that utility is measurable and that the marginal utility of money remains constant as a person spends more of it on a particular good.
Economists like Hicks and Allen have contended that utility is a subjective phenomenon and hence cannot be measured in concrete terms. Further, they contend that the assumption of the constancy of marginal utility of money is not valid. Marshall’s assumption of constant marginal utility of money ignores the “income effect” of the price change, which is often important.
Marshall defended his assumption by pointing out that since consumer spends only a small fraction of his income on a particular good, the marginal utility of money does not change to any significant extent. But this need not necessarily be the case.
On the other hand, Prof. J. R. Hicks has rehabilitated the concept of consumer’s surplus by explaining it in terms of ordinal utility function or indifference curve technique. He has given a measure of consumer’s surplus without assuming utility to be measurable and the marginal utility of money to be constant.
Importance of Consumer’s Surplus:
The idea of consumer’s surplus is not merely bookish.
It has great practical importance and is useful in a number of ways:
In Public Finance:
It is useful to a Finance Minister in imposing taxes and fixing their rates. He will tax those commodities in which the consumers enjoy much surplus. In such cases, the people would be willing to pay more than they actually pay at present. Such taxes will bring in more revenue to the State. They will also mean comparatively less hardship than if taxes were imposed on commodities which do not yield much consumer’s surplus.
To the Businessman and Monopolist:
To the businessman also the concept is very useful. He can raise prices of those articles in which there is a large consumer’s surplus. In such cases, the consumers are willing to pay more than the prevailing price. The seller will be able to raise price especially if he is a monopolist and controls the supply of the commodity.
Comparing Advantages of Different Places:
Our knowledge of consumer’s surplus proves useful when we compare the advantage of living in two different places. A place where there are greater amenities available at cheaper rates will be better to live in. In these places, the consumers enjoy large surplus of satisfaction. Consumer’s surplus thus indicates conjuncture advantages, i.e., the advantages of environment arid opportunities.
Distinction between Value-in-Use and Value-in-Exchange:
Consumer’s surplus draws a clear distinction between value-in-use and value-in-exchange. Commodities like salt and match-box have a great value-in-use but much less value-in-exchange. Being necessaries and cheap things, they yield, however, a large consumer’s surplus. The consumer’s surplus depends on total utility, whereas price depends on marginal utility.
Measuring Benefits from International Trade:
Consumer’s surplus measures benefits from international trade. We can import things cheaply from abroad. Before importing them, we were paying more for similar home- produced goods. The imports, therefore, yield a surplus of satisfaction. We would have paid for them more than what we actually pay. This is consumer’s surplus. The larger this surplus, the more beneficial is the international trade.