With the term consumer surplus, economists indicate the difference between the price a person is willing to pay for a good or service and the real market price. Specifically, the surplus exists when the consumer is willing to pay even more than what the good of interest actually costs. While it may seem like a complex calculation, when you know the data you need, you just need to apply a rather basic equation.
Steps
Part 1 of 2: Defining the Main Concepts and Terms
Step 1. Understand the law of demand
Most people have heard these words in reference to the mysterious forces that govern market economies; however, many do not fully understand the implications of these concepts. The "demand" indicates the demand for a product or service on the market. Typically, if all other parameters are equal, demand for a product drops as its price rises.
For example, suppose a company launches a new model of television. The higher the price at which this appliance is offered, the lower the number of pieces the company can expect to sell. This is because consumers have a limited budget and, by purchasing a more expensive TV, they will have less money available for other products to benefit greatly (food, gasoline, mortgage, and so on)
Step 2. Find out about the law of the offer
On the contrary, the law of supply states that products and services with a high price will be put on the market in large quantities. In practice, sellers want to maximize their profit by selling many expensive products; so if a good or service is very profitable, then producers will scramble to put it on the market.
For example, the day before Women's Day, mimosas increase significantly in price. In response to this phenomenon, the growers who produce them invest a lot of resources in this activity by placing on the market as many mimosas as possible to take advantage of this situation
Step 3. Learn how supply and demand are graphed
One of the most common means used by economists to express the relationship between these two concepts is the classic chart on a Cartesian plane. Usually the quantity (Q) of goods available on the market is placed on the x-axis, while their price (P) is placed on the y-axis. Demand is represented with a sloping curve from the top left to the bottom right corner, while supply is a curve that descends from the bottom left to the top right.
The intersection between the two lines indicates the market equilibrium point, in other words the point where suppliers produce the exact quantity of goods / services required by consumers
Step 4. Understand the concept of marginal utility
This indicates the increased satisfaction a consumer gets from using an additional unit of good or service. In general terms, the marginal utility of goods and services is subject to diminishing returns; that is, each additional unit purchased brings a minor benefit to the consumer. Ultimately, the marginal utility is so low that it "isn't" worth buying an extra unit of product or service.
For example, consider a very hungry consumer. He goes to a restaurant and orders a € 5.00 sandwich. After the first sandwich, he is still a little hungry, so he orders a second one, also for € 5.00. The marginal utility of the second sandwich is slightly less compared to the first, because this provides a lower satisfaction in terms of reducing hunger in relation to its cost. The consumer decides not to buy a third sandwich because he feels full and therefore, in his eyes, we can say that an additional sandwich has virtually zero marginal utility
Step 5. Understand Consumer Surplus
This is generally defined as the difference between "total economic value" or "received value" by the consumer and the actual price paid for the good. In other words, if an individual pays less for a product that is of great use to him, the consumer surplus is perceived as "savings".
To support this concept with a simplified example, let's consider a person who is looking for a used car. He has established a personal budget of € 10,000. If he could buy the car with all the options he wants for € 6,000, then he would have a surplus of € 4,000. So, in his eyes, the car is worth € 10,000, but in the end he finds himself with € 4,000 to spend as he sees fit for other things
Part 2 of 2: Calculate Consumer Surplus from the Supply and Demand Curves
Step 1. Develop a Cartesian chart to compare price and quantity
As previously described, economists use graphs extensively to demonstrate the relationship between supply and demand in the market. Since consumer surplus is calculated based on this relationship, we will use this type of graph.
- As already indicated, arrange the price of goods (P) on the y axis and the quantity of goods (Q) on the x axis.
- The intervals on each axis correspond to the associated values - on the abscissas the intervals for quantities of goods and on the ordinates those for prices.
Step 2. Plot the supply and demand curves for the good or service under consideration
These are usually represented as linear equations (straight lines on the graph), especially in the examples we described earlier. The problem you need to solve may already provide you with the graph of these lines or you will need to plot it yourself.
- As has already been explained in the first section, the line representing the demand has a downward slope from the upper left corner of the Cartesian plane to the lower right corner; while the line that identifies the offer follows an opposite trend.
- These graphical representations vary for each product or service, but should accurately reflect the relationship between demand (in terms of the amount of money consumers could spend) and supply (in terms of the amount of goods purchased).
Step 3. Find the point of balance
As discussed above, the equilibrium point in the relationship between supply and demand is represented by the intersection between the two lines. For example, suppose the break-even point is 15 units at a price of $ 5.00 each.
Step 4. Draw a horizontal line on the price axis at the equilibrium point
Now that you've found it, draw a horizontal line that originates at this point and intersects the y-axis forming a right angle. For the example we have considered, we know that this horizontal line intersects the ordinate axis at the point € 5.00.
The area of the triangle formed by the horizontal line, the vertical segment of the ordinate axis and that of the demand graph represents the consumer surplus
Step 5. Use the right equation
Since the consumer surplus corresponds to the surface of a right triangle (the line that originates in the equilibrium point intersects the y-axis at 90 °) and this is precisely the data you are looking for, you must know the formula for the area of this geometric figure. The equation is: ½ (base x height) or (base x height) / 2.
Step 6. Enter matching numbers into the equation
Now that you know the formula you are ready to do the math.
- In the example above, the base of the triangle corresponds to the quantity of goods required at the equilibrium point, which we know to be 15.
- To find the height of the triangle, we need to subtract the price of the equilibrium point (€ 5.00) from the price corresponding to the intersection point between the ordinate axis and the demand line. Suppose it is € 12, 00 so: 12 - 5 = 7; the height of our triangle is equal to 7.
Step 7. Calculate the consumer surplus
Enter the data into the formula and solve the equation: CS = 1/2 (15 x 7) = 1/2 x 105 = $ 52.50.
