Business, Legal & Accounting Glossary
The consumer surplus theory is based on the assumption that there is a difference between the price the consumer is willing to pay for certain goods or services, called the reserve price and the price they actually pay for them. The theory suggests that along with the product, the customer also receives satisfaction which amounts to more than whatever has been paid; the consumer surplus can, therefore, be thought of as both or either the savings between the price paid and the price the consumer was willing to pay, and the satisfaction received over and above what was expected for the price paid.
A consumer surplus represents the surplus for one individual consumer (i.e. the difference between the price they are willing to pay and the price they actually pay). To understand how to applies to a group of consumers or the economy as a whole, we look at the aggregate consumers’ surplus.
If a consumer is willing to pay $10,000 for a certain car, and he finds one for only $8,000, this buyer has a consumer surplus of $2,000. The concept of consumer surplus is all based on the consumer’s perception.
The theory of consumer surplus was proposed by Jules Dupuit (1804-1866), a French economist. Later developments on the theory were penned by Alfred Marshall (1842-1924), an English economist.
This is the job of marketers. Why do some buyers believe a Ferrari is worth more than a Mercedes when the Mercedes may have more features, be better made, have a better warranty, and other superior benefits? Marketing and consumer preferences have worked to increase the perceived value of the Ferrari to a degree that the cars can sell for ten times the Mercedes, for example.
Marketers seek to make consumers aware of the benefits, whether tangible and measurable or perceived in a product so as to justify its price.
During times of inflation, the price of goods and services increase. The consumer surplus decreases rapidly, and in some cases becomes negative, ie the market price becomes higher then the price the consumer is willing to pay. At this point, the consumer may be forced to either turn away from the purchase or increase their reserve price. This happened in mid-2008 as the price of oil grew rapidly. Many American consumers decided not to drive or to downgrade their cars because the price of oil had become higher than their reserve price.
On a supply & demand diagram (or S&D diagram), the consumer surplus is the area of the chart above the price of the goods or services consumed, and below the demand curve.
The producer surplus is the area above the supply curve but below the market price of the goods or services sold.
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This glossary post was last updated: 15th April, 2020 | 1 Views.