1 Consumer Surplus When consumers buy products in the market they may pay less than the full amount they are willing to pay – they receive consumer surplus.

2 Do you want to buy some eggs? Who here would buy a dozen eggs for $1.59? Who would pay $1.29? Say the actual price of the dozen is $0.89. Do you think the buyers would pay the $1.29 to the grocer when the grocer has a sign out that says $0.89? So if consumers are willing to pay, in this example, more than $0.89, then they receive an extra benefit in the market called consumer surplus.

3 consumer surplus Consumer surplus is an idea people I know have a hard time accepting. Consumer surplus equals the maximum amount you are willing to pay for an item minus what you have to pay. It seems the hard part is distinguishing between what you have to pay and what you would be willing to pay. The amount you would be willing to pay is on the demand curve for each unit of the product. In fact the law of demand is an expression that you are not willing to pay as much for additional units as you did for previous units. The amount you have to pay is market determined.

4 Willing to pay P a b c d e f g h i j k l m n When the price is 24, 0 units are demanded. At P=21, 1 unit is demanded. 21 is the maximum price this person would pay for the first unit. Let’s say the market price is 10. Then the surplus on the first unit is 11. The surplus on the 2nd …, 3rd units is? Q

5 willing to pay You will notice on the previous screen at price 21, the quantity demanded is 1. The area b + d + g + k equals the $21 the consumer would pay for the 1st unit. The area a is under the demand curve but not part of what the consumer would be willing to pay for the first unit. We will add in area a to calculate the consumer surplus. It makes the calculation easier. The second unit would be demanded if the price is 18. The area e + h + i = $18. The area c is under the demand curve but not part of what the consumer would be willing to pay for the second unit.

6 willing to pay The point I am getting to on the previous screen is if we add in areas like a and c, that are really not a part of what consumers are willing to pay, we have an easier calculation to find out what consumers are willing to pay for a certain number of units. It is simply the area under the demand curve out to a quantity. P Q Q1 What consumers are willing to pay for the Q1 units

7 Consumer surplus again P Q ABAB Area A =.5(300)(25-10) =2250 Area B = 10(300) = 3000 Note consumers would be willing to pay for 300 units. But the consumers only have to pay 3000 for the 300 units. So the consumer surplus is area A and equals Say with S & D we get the P = 10 and Q = 300.

8 Refresher on areas The area of a triangle is ½ of the base times the height. The area of a rectangle, of which the square is a special case, is the base times the height. We use these ideas from time to time because they assist in the development of economic ideas.

9 consumer surplus again What do consumers do with the surplus received? They may spend it on more units of the item in question, they may spend it on other items, or they may save it for a rainy day. The point here is that the surplus is useful to the consumer!