How To Calculate Consumer Surplus | With Consumer Surplus Example
How To Calculate Consumer Surplus | With Consumer Surplus Example. Economic supply and demand provides valuable insight into any given market. A basic demand-supply graph used to illustrate the relationship between a product’s market price and the quantity demanded by consumers.
What is Consumer Surplus?
Consumer surplus is an economic measurement to calculate the benefit (which is the surplus) of what consumers are willing to pay for a good or service versus its market price. The theory explains that spending behavior varies with the preferences of individuals. Since different people are willing to spend differently on a given good or service, a surplus is created.
How to Calculate Consumer Surplus
The consumer surplus formula is based on an economic theory of marginal utility. When looking at a demand-supply graph, the demand curve is always going to be sloping downward due to the law of diminished marginal utility. We can measure consumer surplus with the following basic formula:
Consumer surplus = Maximum price willing to spend – Actual price
FORMULA
Consumer surplus = (½) x Qd x ΔP
Where:
Pd = Price at equilibrium, where demand and supply are equal.
Qd = Quantity demanded at equilibrium, where demand and supply are equal.
Pmax = Price the buyer is willing to pay.
ΔP = Pmax – Pd
Producer Surplus
There is another economic metric called the producer surplus which is the difference between the minimum price a producer would accept for goods/services and the price they receive.
Producer surplus = Total revenue – Total cost
How Do Price Floors and Price Ceilings Affect the Market?
A healthy market is able to adapt and settle naturally on an equilibrium point that balances price and quantity. Imposing a price floor or ceiling prevents the market from adjusting to its ideal point of equilibrium and maximum efficiency while also transferring some of the consumer surplus to producers and vice-versa.
A price ceiling is a maximum price a producer is allowed to charge consumers in exchange for a good or service. The government’s impact on the drug market is an excellent example of price ceilings. Let’s say that a pharmaceutical company created a new life-saving drug. The market-price equilibrium, if left to the free market without any restrictions, would be $800, with an expected 50,000 people using the drug per month.
What Is Social Surplus?
It is referred to as economic surplus or total surplus, a social surplus is the sum of consumer surplus and producer surplus. When looking at a demand-supply graph, the social surplus is the total area between the supply curve, the demand curve, and the point of equilibrium.
A deadweight loss, which occurs when the economy is producing at an inefficient quantity, is the loss in total surplus. When the market is operating at optimal efficiency, it’s impossible to increase consumer surplus without reducing producer surplus, and it’s also impossible to improve producer surplus without lowering consumer surplus.
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