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Consumer Surplus


Consumer surplus measures the welfare that consumers derive from their consumption of goods and services, or the benefits they derive from the exchange of goods.  Consumer surplus is the difference between what consumers are willing to pay for a good or service (indicated by the position of the demand curve) and what they actually pay (the market price).  The level of consumer surplus is shown by the area under the demand curve and above the ruling market price



Consider the demand for public transport shown in the diagram. The initial fare is price P1 for all passengers and at this price, Q1 journeys are demanded by local users.  At price P1the level of consumer surplus is shown by the area AP1B. If the bus company cuts price to P2 the demand for bus journeys expands to Q2 and the new level of consumer surplus rises to AP2C. This means that the level of consumer welfare has increased by the area P1P2CB.


Consumer surplus = total willingness to pay for a good or service - the total amount consumers actually do pay.


If a zero fare is charged, consumers will demand bus journeys up to the point where the demand curve cuts the x-axis. When demand for a product is perfectly elastic, the level of consumer surplus is zero since the price that people pay matches the price they are willing to pay. There must be perfect substitutes in the market for this to be the case.  When demand is perfectly inelastic the amount of consumer surplus is infinite. Demand is invariant to a price change.


Dynamic Pricing And Consumer Surplus

Dynamic pricing is becoming more common place with the diffusion of information technology in the economy. Dynamic pricing is when the price the firm charges to customers is sensitive to very short run changes in demand. For example, Coca Cola is experimenting in raising the price of cans from vending machines when the average temperature increases. Hotel bookings systems can change room rates on offer in response to fluctuations in occupancy rates. Changes in price to reflect certain market conditions can take advantage of variations in consumers' willingness to pay for certain items.




E-mail Steve Margetts