How to Calculate Consumer Surplus (Definition and Examples)
By Indeed Editorial Team
Published April 25, 2022
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
You may consider many factors when conducting market research and selecting the optimal pricing plan for a product. Businesses weigh the price at which a consumer buys their goods against the cost of production and the surplus they want to get from the deal. Calculating consumer surplus can be beneficial in analyzing whether you've priced a product profitably. In this article, we define consumer surplus, learn how to calculate it, compare it to producer surplus, and discuss some frequently asked questions.
What is consumer surplus?
Before reviewing how to calculate consumer surplus, you may want to understand more about consumer surplus. The consumer surplus, also known as consumer surplus, is the difference between the price of a product and the price buyers are willing to pay. It's a concept from the marginal utility theory in economics that states customers find additional value in satisfaction from their purchases, which varies and diminishes when consumers purchase more units. According to the hypothesis, as contentment drops with each purchase, the consumer's perceived value of the item also decreases. You can calculate consumption excess using the following formula:
Maximum price willing ‒ actual price = consumer surplus
Maximum price willing is the maximum price that a consumer is willing to pay.
How to calculate consumer surplus
You can compute your consumer surplus online or manually by following the steps below:
1. Plot your demand curve
The demand curve illustrates the consumer demand for your goods, which grows as the price decreases. Demand refers to the number of people interested in purchasing your product. You may calculate it by producing a graph illustrating the number of units that consumers might buy at the listed price. To make your graph, vertically align the price along the Y-axis and horizontally align the quantity of demand along the X-axis.
2. Plot your supply curve
The supply curve depicts the relationship between the cost of a product and the producer's supply. Plot the price vertically along the Y-axis, and map the quantity of supply horizontally along the X-axis to show that the price is a function of supply and demand. Plotting this line alongside your demand curve can provide valuable information about pricing a product.
3. Examine the equilibrium
The equilibrium is the point at which the supply and demand curves intersect and is a helpful data point for determining the pricing of your product. It represents the intersection of what a business can supply and how much the buyers can pay. Once you've established the equilibrium point for the product, you may calculate the consumer surplus below the demand curve but above the equilibrium point. This graph segment illustrates the price a consumer may pay for the goods, regardless of the quantity available.
4. Find the area of the triangle
In your graph, the equilibrium point and demand curve form a triangle. If the equilibrium point is not the same as the fixed price, determine the surplus by subtracting the established price from the highest cost consumers can pay. You can calculate the consumer surplus by using the following formula to get the area of that triangle:
(1/2) x base x height = consumer surplus
Producer surplus vs. consumer surplus
Producer surplus is when a producer accepts a lower price for a product than they receive. To determine when the supply and demand curves meet, draw a graph showing the price increasing as supply increases and the price decreasing as demand increases. This point of intersection is the equilibrium point or the point at which the quantity the business can sell for the price and the quantity it created are equal.
The consumer surplus is greater than the producer surplus. In an ideal pricing situation, the supplier receives a larger payment than the required minimum price. The customer also pays less than the required minimum, which benefits both sides.
Examples of consumer surplus
Here are some real-life examples of consumer surplus:
An example of consumer surplus:
Karl managed the production of 80 sacks of coffee beans. Karl sold his bags of coffee beans at neighbourhood farmer's markets to gauge market demand and pricing structure. After pricing the packs at $20, he did not make a sale, but Karl reduced the price to $15 and immediately sold 20 sacks. He discounted the coffee to $10 and sold 50 bags. Later, Karl reduced the price to $8 per bag and sold all 80 bags. Karl discovered his ideal selling price: 80 coffee packets, costing around $8 per packet.
Some clients paid $15 for his product, showing a social surplus. He could now calculate the triangular area between his equilibrium point and the demand curve, representing his social surplus. He might alternatively calculate his consumer surplus by deducting $8 from $15, which is $7.
An example of consumer surplus:
A shopper is in the market for a new TV set. They're specifically looking for a 42" OLED smart TV with a maximum budget of $1,300. They discover a television that meets their exact specifications for only $950. The $350 difference in price between what they paid and what they were willing to spend represents social surplus, which they can now spend on other items, goods, or services. Therefore, a consumer surplus occurs when you believe you received a good bargain because you paid less than expected.
Consumer surplus FAQs
Here are answers to some common questions about consumer surplus:
How does elasticity affect consumer surplus?
Elasticity is a term that refers to the degree to which a product's demand might fluctuate in response to external variables. For example, the demand for party balloons may shift in a recession, as they are unnecessary, so they have high elasticity. Electricity prices have low elasticity and may remain stable as most people find electricity necessary. When a product is perfectly inelastic, clients can pay any cost they want, and the consumer surplus is endless.
Can you convert consumer surplus into producer surplus?
The difference between consumer and producer surplus determines who gains an equilibrium advantage. You may convert consumer surplus to producer surplus by raising the price. If you can show that buyers can pay more than the equilibrium price for a product, you can increase its price. Increased profit margins on individual products may compensate for the decline in demand. The increased costs can assist in converting consumer surplus to producer surplus, so the product sells at a higher price than the consumer can accept.
How does the law of diminishing marginal utility affect consumer surplus?
When a person uses a product, each purchase grants less enjoyment because of diminishing marginal utility, which shows that consumers are less likely to buy multiples of the same product. If you sell toothbrushes, you might find that customers pay $2 for a second toothbrush but don't want to spend more money on a third. The following equation, according to the hypothesis, is correct:
Total utility - (price x quantity) = consumer surplus
What assumptions does the consumer surplus theory make?
The following are assumptions to consider when calculating social surplus:
No substitutions: This formula does not take replacements into account. It only considers the demand and supply of a single commodity at a time.
No external actors on demand: A graph of supply and demand curves accounts only for the demand unaffected by price changes. It does not take into consideration external influences, such as economic developments or purchasing trends.
Measurable utility: Assume you can measure anything to understand the rule of diminishing marginal value. This includes quantifying the satisfaction consumers get from purchasing a product.
Independent utility: The law of marginal utility disregards a customer's satisfaction gained from purchasing a comparable product. It also ignores how that satisfaction may lessen their contentment with a product.
Is consumer surplus beneficial?
Consumer surplus is an idea that comes from the product price and is beneficial or detrimental, depending on whether one is a consumer or a producer. A small consumer surplus shows that the producer profits from the product more than the equilibrium level. In contrast, a low consumer surplus indicates that the consumer receives less satisfaction from the goods and pays more than the worth of the product. While this is helpful for consumers, producers earn less profit per unit, and industry innovation requires businesses to enhance their product and customer interactions.
What's the difference between consumer surplus and economic surplus?
You can calculate economic surplus, or overall welfare, by summing consumer and producer surplus. In a stable economy, the consumer and producer both receive the maximum surplus attainable at their equilibrium points. This is an effective market where all participants derive satisfaction and benefit from the deal, including the economy.
How can you reduce social surplus?
Businesses with substantial market power can diminish consumer surplus by increasing their prices above equilibrium. This is possible if the business controls a large part of the market and the consumers can't switch to a competitor offering a lower price. A business may do this for two reasons:
Monopoly: Without competitors, businesses can price their products well above the competitive equilibrium point, as consumers have no alternatives. This is true if the product requires stable demand levels.
Brand loyalty: A business can increase the price above the initial equilibrium point if it instills brand loyalty in its clients and fosters increased customer pleasure. If a customer cannot switch brands, they may pay a higher price for the goods.
Explore more articles
- What Is CAD? (What Industries Can Benefit From Its Use?)
- What Is User Acceptance Testing? (With Benefits and How-to)
- How to Improve and Maintain Sales Motivation (With Tips)
- 6 Asset Management Software Tools and Their Importance
- What Is Artificial Intelligence Analytics? (With Examples)
- What Is a Content Hub? (With Benefits and How-to Steps)
- Tips on Creating an Ideal Workspace Design (With Benefits)
- Customer Service vs. Customer Experience: How They Compare
- 8 Ways to Manage Your Manager (And Why It's Important)
- What Is Enterprise Service Management? (With Key Principles)
- What Is a Backorder? (Including Pros, Cons, and Uses)
- Important Strategies for Project Execution (With Vital Tips)