![[personal profile]](https://www.dreamwidth.org/img/silk/identity/user.png){kind=small}
philmophlegmThe subject of this post was prompted by a question asked by eledonecirrhosa. So thank you for that.
Before I get onto Consumer Surplus, I'm going to have to ask you to do some revision and read this post on Supply and Demand first. And then this one about Elasticity.
Right then. Consumer surplus...
If you look up this concept in an ordinary Economics textbook (or even a popular internet encyclopedia), you'll get an explanation with a diagram that uses curves and axes and dotted lines and triangles. Now I remember when reading the foreword of 'A Brief History of Time' that Stephen Hawking's editor warned him that every equation he put in that book would halve his sales figures. I think Professor Hawking limited himself to two. Inspired by that, I'm going to try to limit the number of diagrams and curves and axes and stuff that I use in these economics posts. So I'm going to expain consumer surplus without curves.**
Think of the last thing that you bought. How much did you pay for it? If the price was a little bit higher, would you still have bought it? If the price was twice as much, would you still have bought it? If the price was ten squillion times as much, would you still have bought it? Consumer surplus is very simply the extra amount that you would have been willing to pay for it over and above what you did pay for it. Or, more usually, it's the aggregate of such extra amounts for all consumers.
Thus aggregate consumer surplus is an important concept in considering the overall welfare of consumers in society. If you or I can get something we want for less than we would be willing to pay for it, then clearly the benefit to us is greater than the cost. So more consumer surplus is better for us as consumers.*
Obviously, consumer surplus is greater if prices are lower. But also, consumer surplus is greater if there is more choice. Why? Because while you might have been willing to pay £50 for a really comfortable and stylish pair of black shoes, perhaps you would be willing to pay £55 for a really comfortable and stylish pair of purple shoes. A second person might be prepared to pay £55 for the black but only £50 for the purple. Let's say that both pairs of shoes cost £40. You buy the purple shoes and your friend buys the black. Total consumer surplus for both of you is £15 + £15 = £30. If there were only black shoes at £40, then your friend would still have a surplus of £15, but yours would only be £10 - the difference between the price and what you were prepared to pay. So everything else being equal, choice is good.
Now, remember elasticity? Price elasticity of demand has some implications for consumer surplus. For goods with price-inelastic demand, consumer surplus will be higher because some consumers are still willing to buy the item even if the price shoots up - which must mean that the price they are willing to pay is higher, hence higher consumer surplus.
Next, think about producers. Producers naturally want to get the best price they can for their goods. If they can work out which consumers are the ones who are willing to pay more, and somehow separate their prices, then this is what they'll try to do (to maximise their own producer surplus*). A good example of this is train tickets. Poor students are only willing to pay £x per journey. Rich commuters are willing to pay more - up to £y per journey. The train companies know that most commuters have to take rush hour trains, so they can charge commuters more by charging more for rush hour trains. This is called price discrimination.
* There is also a concept called 'Producer Surplus', which is the amount by which the selling price of an item exceeds the amount that a supplier would have been willing to sell it for.
** Just in case you really want a curve, you can have one. But go and read the rest of the post first. Go on...
OK, here's the curve, if you really want it:
That's a demand curve, which you should recognise from my post on Supply and Demand. The lower the price (P) of something, the greater the demand (Q) for it. You can also use the same graph to illustrate consumer surplus. If the price is P2, then aggregate consumer surplus is shown by the triangle formed by the price axis, the demand curve (the blue line) and the price P2 horizontal line.
Before I get onto Consumer Surplus, I'm going to have to ask you to do some revision and read this post on Supply and Demand first. And then this one about Elasticity.
Right then. Consumer surplus...
If you look up this concept in an ordinary Economics textbook (or even a popular internet encyclopedia), you'll get an explanation with a diagram that uses curves and axes and dotted lines and triangles. Now I remember when reading the foreword of 'A Brief History of Time' that Stephen Hawking's editor warned him that every equation he put in that book would halve his sales figures. I think Professor Hawking limited himself to two. Inspired by that, I'm going to try to limit the number of diagrams and curves and axes and stuff that I use in these economics posts. So I'm going to expain consumer surplus without curves.**
Think of the last thing that you bought. How much did you pay for it? If the price was a little bit higher, would you still have bought it? If the price was twice as much, would you still have bought it? If the price was ten squillion times as much, would you still have bought it? Consumer surplus is very simply the extra amount that you would have been willing to pay for it over and above what you did pay for it. Or, more usually, it's the aggregate of such extra amounts for all consumers.
Thus aggregate consumer surplus is an important concept in considering the overall welfare of consumers in society. If you or I can get something we want for less than we would be willing to pay for it, then clearly the benefit to us is greater than the cost. So more consumer surplus is better for us as consumers.*
Obviously, consumer surplus is greater if prices are lower. But also, consumer surplus is greater if there is more choice. Why? Because while you might have been willing to pay £50 for a really comfortable and stylish pair of black shoes, perhaps you would be willing to pay £55 for a really comfortable and stylish pair of purple shoes. A second person might be prepared to pay £55 for the black but only £50 for the purple. Let's say that both pairs of shoes cost £40. You buy the purple shoes and your friend buys the black. Total consumer surplus for both of you is £15 + £15 = £30. If there were only black shoes at £40, then your friend would still have a surplus of £15, but yours would only be £10 - the difference between the price and what you were prepared to pay. So everything else being equal, choice is good.
Now, remember elasticity? Price elasticity of demand has some implications for consumer surplus. For goods with price-inelastic demand, consumer surplus will be higher because some consumers are still willing to buy the item even if the price shoots up - which must mean that the price they are willing to pay is higher, hence higher consumer surplus.
Next, think about producers. Producers naturally want to get the best price they can for their goods. If they can work out which consumers are the ones who are willing to pay more, and somehow separate their prices, then this is what they'll try to do (to maximise their own producer surplus*). A good example of this is train tickets. Poor students are only willing to pay £x per journey. Rich commuters are willing to pay more - up to £y per journey. The train companies know that most commuters have to take rush hour trains, so they can charge commuters more by charging more for rush hour trains. This is called price discrimination.
* There is also a concept called 'Producer Surplus', which is the amount by which the selling price of an item exceeds the amount that a supplier would have been willing to sell it for.
** Just in case you really want a curve, you can have one. But go and read the rest of the post first. Go on...
OK, here's the curve, if you really want it:
That's a demand curve, which you should recognise from my post on Supply and Demand. The lower the price (P) of something, the greater the demand (Q) for it. You can also use the same graph to illustrate consumer surplus. If the price is P2, then aggregate consumer surplus is shown by the triangle formed by the price axis, the demand curve (the blue line) and the price P2 horizontal line.
