The Importance of Consumer Surplus

Consumer surplus is a topic that appears in many economics syllabi across the globe. It is one of those concepts that are tucked away and given only limited treatment in many cases. However, it is a very important economic concept that does go to the heart of the subject.

The basic idea is very simple. Think about a product or service that you might choose to buy. Let us use tickets for the Glastonbury Festival as an example. The tickets for all three days of the festival for 2007 were priced at £145. Given the popularity of the festival, the 137,500 tickets sold out in 45 minutes when they went on sale on Sunday 1st April.

Now, assume that you were one of the lucky ones who got a ticket: £145 was the market price you had to pay to buy your ticket. What does this price represent? It represents the value that you think you will get from attending the Festival. Three days of top quality music and entertainment from some of the biggest music acts on the planet. For some, that price represents a bargain. It also represents an opportunity cost. You could have used that money to buy any number of other things but presumably felt that the satisfaction or utility gained from acquiring tickets for the Festival represented greater utility than the next best alternative.

Glastonbury - how much would you be prepared to pay for a ticket? Copyright: Sue Ashwin 2005

Whenever we pay money to acquire something we do need to consider the opportunity cost and the notion of value. Every purchase says something about the value that we place on products or services. For the most part we are not conscious of this. We use money as a means of expressing this value - it is something that can mean a great deal to all of us as we generally have a common understanding of what value means to us in terms of money.

If we bear this in mind, we can now extend the analysis a little. Ask yourself this question: what is the maximum price that you would have been prepared to pay to acquire a Glastonbury ticket? If Michael Eavis had decided to set the price at £250 for the three days, would you still have purchased your ticket? What about a price of £300? Or how about £500?

If we look at the market for Glastonbury tickets, we can see that there were 395,000 people who registered to try and get tickets. This means that there were a large number of people who ended up disappointed. Of those people who registered to buy Glastonbury tickets, there are likely to be some who certainly would have been prepared to pay significantly more than the market price for a ticket. We might expect the demand curve for the tickets to look something like the diagram below.

The diagram shows that if the price were set at £500 per ticket then there would have been some people (Q1) prepared to pay that sort of price to purchase a ticket. These people might have the incomes to be able to afford to pay that sort of price but also might value the experience they get from going to Glastonbury at more than what that £500 could have bought.

A similar story applies if the price were set at £400. In this case Q2 people would have been prepared to pay this price to acquire their tickets and clearly valued the experience above the opportunity cost of that sum of money to them.

If we now look at this in terms of the actual market price paid to get the tickets, we can see that for a number of people, the price of £145 represents a far lower price than they were prepared to pay to acquire their ticket. This means that they get a great deal of surplus value from the purchase of the ticket. We can use the difference in what they were prepared to pay and what they actually aid as some indication of the extent of this surplus.

For those prepared to pay £500 per ticket, the surplus value is 500 - 145 = £355. For those willing to pay a maximum of £400, the surplus value is 400 - 145 = £255.

This is how we can start to develop an understanding of consumer surplus. To really get to grips with it, we must understand the nature of the demand curve and marginal analysis. As price falls, the demand curve suggests that the number of people willing and able to pay for tickets would rise. For every individual, there would presumably be some upper limit of price that they would be prepared to pay. Above that limit, the opportunity cost of parting with that sum of money becomes too great - the sacrifice foregone would be excessive. The area under the demand curve therefore shows the total value that consumers get, measured in monetary terms. We have to subtract from this the amount of money that consumers have to lay out to acquire the tickets. The difference is the level of consumer surplus. This is shown in the diagram below.

This diagram shows the total value gained by consumers from the purchase of the tickets.

This diagram shows the total consumer surplus when the amount paid out for the tickets has been subtracted.

Consumer surplus can be used as a measure of the welfare of the consumer. Welfare can be seen as the well-being of an individual or group. Any improvement in that well-being can be seen as being a 'good' thing and any reduction being a 'bad' thing. This can help us to utilise the concept in all sorts of ways to look at the effects of decision making.

Some examples:

The government are contemplating the idea of expecting individuals to pay to enter museums and public art galleries. Representatives of tourist groups are very much against the idea as are those who support public access to art and culture. Copyright: Cristina Cascais, from stock.xchng.

The All England Tennis Club, which runs the annual Wimbledon tennis championships, is under pressure to reduce the length of queues of people hoping to buy tickets. There is a suggestion that prices for tickets are simply too low. Copyright: Albert Lee, from stock.xchng.

The plans by the government to implement a national road pricing scheme are coming under severe pressure from some motoring groups and road users as being unfair. The government are arguing that there will be benefits to all of the policy and that it will reduce congestion on the roads. Copyright: Richard Styles, from stock.xchng.

The Competition Commission is investigating the market power of the big four supermarkets. It has been suggested that the supermarkets are too big and that they exert too much monopoly power in the grocery market. Copyright: Sanja Gjenero, from stock.xchng.

There have been plans to find a way of improving the main A303 trunk road in parts of Wiltshire for some time - particularly the stretch that passes Stonehenge. Environmental campaigners are concerned that changes to the road will damage an area of natural beauty, and that what will be lost will never be able to be recovered, which is almost impossible to put a value on. Copyright: John Evans, from stock.xchng.

The government are planning to try to discourage the use of 4 x 4 vehicles (so called 'gas guzzlers') by increasing the vehicle excise duty on the vehicles to £400. Copyright: Alain Varie, from stock.xchng.