In this article we will discuss about the theoretical and practical uses of the concept of consumers surplus. The uses are: 1. Distinction between Value-in-use and Value-in-Exchange 2. Importance in Welfare Economics 3. Comparison of Gains from the International Trade 4. Comparison of Living Conditions 5. Useful to a Monopolist 6. Environmental Benefits to Consumers 7. Practical Importance in Public Finance.
The concept of consumer’s surplus is not a theoretical toy. It has practical uses also. It is widely used in cost-benefit analysis and other areas of applied economics as an approximate measure of changes in welfare. Although the actual measurement of consumer’s surplus is a difficult task as utility is a purely psychological concept. Yet the concept has a great theoretical and practical importance.
Some of the theoretical and practical uses of the concept are discussed below:
1. Distinction between Value-in-Use and Value-in-Exchange:
Consumer’s surplus points to the distinction between the use value (i.e., utility) and the exchange value (i.e., the market price) of a thing. The former is reflected in the individual demand price and the latter in the market price. Hence, consumer’s surplus shows that these two values are not always equal.
2. Importance in Welfare Economics:
The concept of consumer’s surplus has a great importance in modem welfare economics, because it measures individual welfare. The larger the consumer’s surplus is, the highest the welfare level of an individual is likely to be. We are sometimes concerned with a change that alters the price of a product, that is, not with the total benefits derived from the existence of a particular commodity but with the change in benefit due to a change in the price of the commodity.
Equally, the concept of consumer’s surplus may be applied to such changes. In terms of a demand curve, consumer’s surplus may be restated as follows: The benefit derived from the provision of a commodity or service at a particular price is the area under the demand curve at that price, and the consumer’s surplus is that benefit minus the sum of money the consumer actually pays; the change in benefit is the change in the area due to a price change; and the change in consumer’s surplus is the change in benefit minus the change in the money some paid.
Suppose, we were to aggregate all individual demand curves for a commodity to obtain the market demand curve; could we also aggregate the consumer’s surpluses to get consumer’s surplus? If we could, we have a powerful way of estimating consumer benefits from, say, an innovation that will lower the price of a good.
All that appear to be required is the statistical estimation of demand functions. Suppose, for example, that an authority is contemplating building a river bridge that will be the area under the demand curve, and this can be compared with the cost.
Consumer’s surplus, therefore, would appear to be a powerful tool in the evaluation of proposed public projects, and it is indeed regarded by some commentators as a central tool in cost-benefit analysis.
3. Comparison of Gains from the International Trade:
Consumer’s surplus from international transactions (say, from the trade between India and U.S.A.) enables us to compare the relative gains from the international trade of the different countries. Larger consumer’s surplus from such transactions enjoyed by a country is likely to make its gains higher than that of another country.
4. Comparison of Living Conditions:
Furthermore, consumer’s surplus enjoyed by the different people at different places and in different times, enables us to compare their living standards. Larger consumer’s surplus indicates a higher living standard.
5. Useful to a Monopolist:
While practising price discrimination, a monopolist may charge different prices for the same commodity from the different buyers (i.e., higher prices from the affluent buyers and lower prices from others) in such a way that none enjoys any consumer’s surplus. In fact, if the supplier had a monopoly and could practice price discrimination, he could extract as revenue the whole of the area under the demand curve.
6. Environmental Benefits to Consumers:
Consumer’s surplus shows how lucky the citizens of modern efficient communities are, as they are getting a vast multitude of goods of daily necessities (e.g., post cards, newspapers, telephone services, etc.) at relatively low prices. From these goods they enjoy much greater satisfaction than what they pay for these.
Similarly, our knowledge of consumer’s surplus proves useful when we compare the advantages of living at two different places. A place where there are greater amenities of life at cheaper rates will be better to live in, as the people at such a place can enjoy a larger amount of satisfaction from his spending.
7. Practical Importance in Public Finance:
The concept has a great practical importance to the government in determining the desirability of imposing a tax on a certain commodity. A tax imposed on a commodity tends to raise its price and to reduce consumer’s surplus thereby, but it yields some revenue to the government. The finance minister is to compare the loss of consumer’s surplus to the increase in tax revenue. A tax is justified when the loss in consumer’s surplus becomes less than the increase in tax revenue; otherwise it will be harmful to society.
Similarly, the concept is useful to make a case for government subsidies or bounties in some situations, where it can be shown that the additional net satisfaction conferred through subsidies upon consumers will outweigh the loss of satisfaction represented by the money cost involved. It shows that the concept of consumer’s surplus has a considerable importance as a guide to public policy.
Doubts about Use and Validity of the Concept:
Other economists are much more doubtful about the use and validity of the concept. The main concern is that, once the assumptions under which Marshall originally drew up his measure of consumer’s or consumer’s surplus are relaxed, the area under the demand curve will not be an accurate measure of benefits. There are two main reasons for this skepticism.
First, changes in the price of the good will alter real income, the extent to which will depend on the proportion of total expenditure that is spent on the good, and this in turn will shift the original demand curve. Thus, one of the initial assumptions required to measure consumer’s surplus and they will coincide only under very restrictive conditions.
Second, there is the problem of the interrelationships between the demands for different commodities. Suppose, the price of X falls and more money is now spent on the commodity; the extra purchases result in an increase in consumer’s surplus. But, the net benefit will be less because there will have been a reduction in the purchases of goods and this will lower the sums of consumer’s surplus arising from the purchase of them.
Whether the concept of consumer’s surplus will continue to be used in economic inquiry remains to be seen. It is certainly an issue that continues to be strongly debated.