Consumer surplus is the difference between what consumers are willing to pay for a good or service and what they actually pay.
Detailed Explanation:
Have you ever been to an auction? The auctioneer’s job is to find the buyer willing to pay the highest price for a product. Usually, when we purchase a good or service, we don’t pay the highest price we would be willing to pay. We benefit when we pay a price lower than we would be willing to pay. Economists call this benefit “consumer surplus.” The auctioneer tries to eliminate consumer surplus by finding the person who would pay the highest price. However, the auctioneer may not always succeed if the final bid is lower than what the buyer was willing to pay.
To explain the concept of consumer surplus, let’s say you have three tickets to a Brad Paisley concert. The concert is sold out, and due to an emergency, you can’t attend. Your friends Joy, Linda, George, Kathy, and Michelle are interested in buying the tickets. Michelle is a big fan, and she is willing to pay $150 for a seat. On the other hand, George isn’t a big Paisley fan and would only pay up to $50. Each friend has a different spending limit. Economists call the maximum amount a buyer is willing to pay for a product or service their “willingness to pay.”
You could have sold Michelle a ticket for $150, Joy a ticket for $140, and Linda a ticket for $90. However, you sold your tickets for $90 each to maintain close friendships. Michelle is thrilled because she is “saving” $60. The $60 savings is her consumer surplus, which equals the amount she is willing to pay ($150) minus the purchase price ($90). Joy is also happy because her surplus equals $50. Linda is indifferent because the price she is paying equals the price she is willing to pay, resulting in a consumer surplus of $0. The total surplus is the sum of Michelle’s, Joy’s, and Linda’s consumer surpluses, which equals $110. It is important to note that if you chose to sell each ticket at each friend’s willingness to pay, the consumer surplus would be $0. (Michelle and Joy might be happy when they purchase the tickets but upset when they learn that Linda only paid $90.)
Consumer surplus measures the benefit to consumers when the price of a good or service is lower than what they are willing to pay. Assume the graph below represents the demand curve for bottled water. The price is $1.75 (P). Imagine you are driving a long distance and feeling dehydrated and willing to pay $4.00 for a bottle of water. This is more than anyone else is willing to pay, so point A represents your demand. Since your actual price is $1.75, your individual consumer surplus is $2.25 (willingness to pay minus price paid), shown as AC on the graph. All buyers willing to pay more than the actual price benefit from consumer surplus. The individual consumer surplus decreases for each additional buyer. For buyers willing to pay $3.00, their consumer surplus would be $1.25, represented by CF on the graph. Finally, the last buyer would purchase at $1.75 and have no consumer surplus. The total of all individual consumer surpluses is the total consumer surplus, shown as the shaded triangle ABC.
Here's a fun video explaining consumer and producer surpluses.
