Reviewed by Feb 19, 2021| Updated on
Consumer surplus is an economic indicator of the benefits to the product. Consumer surplus arises when the price, customers pay for a product or service, is lower than the price they should pay. It's a measure of the extra benefit customers get because they pay less for something than they were willing and able to pay.
The consumer surplus concept was developed in the year 1844 to calculate the social benefits of public goods, such as national highways, canals, and bridges. It has been an effective tool in welfare economics and governmental tax policies formulation.
Consumer surplus is based on the marginal utility theory under economics, which is the additional value a product receives from another unit of a good or service.
Based on the personal choice, the value a product or service offers varies from individual to individual. Typically, because of the decreasing marginal utility or additional benefit they receive, the more good or service consumers have, the less they are willing to spend more for it.
The demand curve is a graphical representation used to calculate the surplus for consumers. This describes the relationship between the price of a commodity and the quantity of the product being demanded at that point with the price being drawn on the y-axis of the appropriate graph and quantity drawn on the x-axis. Due to the law of diminishing marginal utility, the demand curve is sloping downward.
Consumer surplus is calculated as the area underneath the downward-sloping demand curve or the amount a consumer is ready to spend for a given quantity of a good and beyond the actual market price of the good represented with a horizontal line drawn between the y-axis and demand curve.
Consumer surplus can be measured either on an individual or aggregate basis, depending on whether the demand curve is individual or aggregated. Consumer surplus constantly increases as the price of a good falls and declines as the price of a good increase.
For instance, assume consumers are willing to pay Rs 50 for the first product unit A, and Rs 20 for the 60th unit. If 60 units are sold at Rs 20 each, then 59 of the units are sold at a consumer surplus, presuming a constant demand curve.