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In mainstream economics, consumer surplus is the difference between the highest price a consumer is willing to pay and the actual price they do pay for the good (which is the market price of the good). In other words, consumer surplus is the difference between what a consumer is willing to pay and what they actually pay for a good or service.
Economic surplus refers to two related quantities: consumer surplus and producer surplus. The producer surplus is the difference between the actual price of a good or service–the market price–and the lowest price a producer would be willing to accept for a good.
Economic surplus is calculated by combining the surplus benefit that is experienced by both consumers and producers in an economic transaction.
Key Takeaways
- In mainstream economics, economic surplus refers to two related quantities: consumer surplus and producer surplus.
- Consumer surplus is the difference between the highest price a consumer is willing to pay and the actual price they do pay for the good, or the market price.
- The producer surplus is the difference between the actual price of a good or service–the market price–and the lowest price a producer would be willing to accept for a good.
- Economic surplus is calculated by combining the surplus benefit that is experienced by both consumers and producers in an economic transaction.
Consumer Surplus
A consumer is an individual who purchases products and services. Consumer surplus is one way to determine the total benefit that consumers receive from their goods and services. If a consumer is willing to pay more for an item than the current asking price–the market price–then they are theoretically receiving an additional benefit by purchasing the item at that price. If the price was their maximum willingness to pay, theoretically, they would get less benefit from the purchased product.
For example, before making a purchase, most consumers decide how much they are willing to spend on an item. Suppose there is a college student that decides that a pair of sneakers is worth no more than $80. If the price of the sneakers is $100, then the student may decide not to buy them. However, if the price of the sneakers is $60, the student will likely make the purchase. They may also feel like they got a special deal. And in economic terms, they've experienced a surplus of $20: the difference between the maximum amount the student was willing to spend ($80) and the market price of the sneakers ($60).
For consumers, a surplus represents a monetary gain because they are able to purchase an item for less than the highest price they would be willing to pay.
Economic Surplus
In an economic transaction, a producer is the entity or individual that manufactures goods and services. When a producer sells a product, it must determine a price for that product.
Suppose that the manufacturer of the sneakers must spend $30 to manufacture, market (advertise), and distribute each pair of sneakers. The manufacturer of the sneakers doesn't want to lose money by selling the shoes, so $30 is the minimum they would be willing to charge for the sneakers. Because the manufacturer wants to create a profit, they will likely elect to charge far more than $30 for the sneakers. The manufacturer must then choose a price that will make the sneakers attractive for a large number of consumers. (While they may be tempted to price the sneakers at a high price–like $200, $300, or $500–in order to garner a huge profit, this would likely be unsuccessful because many consumers would consider this price too expensive.)
If the price of the sneakers is $60, then the sneaker manufacturer will earn a profit of $30 on each pair of sneakers that is sold. This profit is also known as the producer surplus.
For every economic transaction, there may be both producer surplus (or profit) and consumer surplus. The aggregate–or combined–surplus is referred to as the economic surplus.
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Consumer Surplus
Special Considerations
The French civil engineer and economist, Jules Dupuit, first developed the concept of consumer surplus in the mid-19th century. However, it was the British economist Alfred Marshall who popularized the term in his book "Principles of Economics" published in 1890). In fact, economic surplus is sometimes referred to as Marshallian surplus, after Alfred Marshall.
In traditional economics, the intersection of the supply and demand curves provides the market price (also called the equilibrium price) and quantity of a good. Before the supply curve and the demand curve intersect, there are many points where the price that consumers are willing to pay for a good is lower than the price that producers are willing to accept.
At the market (equilibrium) price, then, a surplus is created for both parties: consumers who would have paid more only have to pay the market price, and suppliers who would have accepted less receive the market price. The extra benefit that both consumers and suppliers get in the transaction is referred to as the economic surplus.
On a supply and demand diagram, consumer surplus is the area (usually a triangular area) above the equilibrium price of the good and below the demand curve. The point at which a price stabilizes–so that both consumers and producers receive maximum surplus in an economy–is known as the market equilibrium.
This area reflects the assumption that consumers would be willing to buy a single unit of the good at a price higher than the equilibrium price, plus a second additional unit at a price below that (but still above the equilibrium price). However, what they actually end up paying is just the equilibrium price for each unit they buy.
Likewise, in the same supply and demand diagram, the producer surplus is the area below the equilibrium price but above the supply curve. This reflects the assumption that producers would have been willing to supply the first unit at a price lower than the equilibrium price, and an additional (second) unit at a price above that (while still below the equilibrium price). However, in the market economy, producers receive the equilibrium price for all the units they sell.