The concept of consumer surplus was developed in 1844 to measure the social benefit of public goods such as national highways, canals and bridges. It has been an important tool in the field of welfare economics and in the formulation of tax policies by governments. Well, before going further, it is necessary to know “what is a consumer surplus?”.
So, consumer surplus is defined as the difference between a consumer’s willingness to pay for a product, service or good and its actual price. Usually consumer surplus occurs when the consumer is willing to pay more for a given product than the actual price of the product.
Consumer surplus = willing to pay – actual price
For example- actual price of a toy car is $10 while jack is willing to pay $15 for the toy car. Hence, jack’s surplus is $5 ($15 – $10).
Consumer surplus is based upon the economic theory of “Marginal utility”, which states that the price an individual is willing to pay for a product or service reflects the amount of utility he receives for that service or product. The utility of goods or services provides varies from person to person based on his personal preference. Consumer surplus always increases when prices of product falls down and it decreases when the prices of product rises. The demand curve is a graphic representation used to calculate the consumer surplus. The demand curve is always downward sloping because of “law of diminishing marginal utility”. Consumer surplus is infinite when the demand curve is inelastic and zero in case of a perfectly elastic demand curve.
Consumer surplus have great emphasis on economy. It not only helps government in fixing tax liabilities but also in determining prices of public utilities.