What is Consumer Surplus?
A Consumer Surplus is present when the actual prices paid by consumers for goods and services are less than the maximum prices at which they would be willing to pay.
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How Does a Consumer Surplus Work?
In economics, a consumer surplus is measured to quantify the monetary benefits resulting from favorable (or unfavorable) market conditions.
Since pricing is a byproduct of the prevailing market competition within the economy, higher levels of competition lead to more benefits on the consumer side.
On the other hand, increased competition in the market tends to contribute to a more challenging environment to obtain higher profit margins.
Generally speaking, the prices of goods and services tend to decline once the product has become commoditized. In particular, the barriers to entry in a commoditized market are low and the level of competition is high, meaning that competition becomes oriented around prices, which tends to erode the profitability of market participants.
So if the price paid by consumers to complete the purchase of a product or service is less than the maximum price that they would be willing to pay for it (i.e. the “ceiling” as set by supply/demand), there is a consumer surplus in the market.
How to Calculate Consumer Surplus
The difference between the actual price paid and the maximum price that consumers are willing to pay represents the marginal benefit received by the consumers.
Simply put, consumers can purchase goods and services for less than the maximum amount they would be willing to pay.
The concept of a consumer surplus is derived from the economic theory of marginal utility, which is defined as the additional benefit a consumer receives from one more unit of a good or service.
All else being equal, the greater the supply of a good or service (i.e. the number of sellers and available options) and the more accessible that it is, the more likely that consumers already have it.
For those not in possession of the good or service, the amount that consumers are willing to spend tends to decline given the environment that favors buyers over sellers.
The relationship between pricing and the consumer surplus is the following:
- Higher Pricing → Increased Consumer Surplus
- Lower Pricing → Decreased Consumer Surplus