Question

Explain how consumer surplus is derived from the difference between the willingness to pay and the market equilibrium price. Please use examples to support your posting.

Answer 1

ANSWER:

Consumer surplus refers to the gap between the consumers' willingness to pay for a good based on their preferences and the actual price paid by them, or the equilibrium price. Economists compute consumer demand as per the law of diminishing marginal utility. How much price the consumer is willing to pay for one additional commodity depends upon how much of this commodity the consumer already holds. Because according to the terms of the computation, the demand for one more good falls with each sale, the acceptable price for that commodity certainly diminishes with each sale as well. On graph, it can be determined as the area below the demand curve (which indicates the consumer's willingness to pay for a commodity at different prices) and above the price line.

Example: The equilibrium quantity demanded is 5 units of the commodity, and market price is $5. The market demand curve indicates that consumer’s consumers' willingness to pay is at least $9 for the first unit of the commodity, $8 for the second unit, $7 for the third unit, and $6 for the fourth unit. But consumers can purchase 5 units of the commodity for just $5 per unit. Thus the surplus from the first unit purchased will be $4 ($9- $5 = $4). In similar way, the consumer surpluses from the second, third, and fourth units purchased will be computed as $3, $2, and $1. The consumer surplus is enclosed in the graph.

GRAPH 10 9 Consumer surplus Equilibrium price Market demand curve 0 1 2 3 45 678 9 10 Units demanded