Consumer surplus is a term used by economists to describe the difference between the amount of money consumers are willing to pay for goods and services and the actual market price. Specifically, consumer surplus occurs when consumers are willing to pay "more" for a good or service than they are currently paying for. Although it sounds like a complicated calculation, calculating consumer surplus is actually an easy equation if you know what factors to include.
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Part 1 of 2: Define Key Concepts and Terms
Step 1. Understand the law of demand
Most people have heard the phrase "demand and supply" used to describe the mysterious forces that rule the market economy, but many people do not understand the full implications of this concept. "Demand" refers to the desire to obtain a good or service in the market. In general, if all other factors are equal, the demand for a product will decrease as the price rises.
As an example, let's take a company that is about to release a new model television. The higher the price they charged for this new model, the fewer televisions they could expect to sell overall. This is because consumers have a limited amount of money to spend and, by paying for a higher-priced television, they may have to forego shopping for other things that can provide greater benefits (groceries, gas, debt repayments, etc.)
Step 2. Understand the law of supply
In contrast, the law of supply dictates that products and services that demand a high price will be supplied in large quantities. In essence, people who sell goods want to earn as much income as possible by selling lots of expensive products, so, if one particular type of product or service is very profitable, then producers will rush to produce that good or service.
For example, let's take the moment just before Mother's Day, tulips get very expensive. In response to this, farmers who have the ability to produce tulips will devote all their resources to this activity, producing as many tulips as possible to take advantage of situations when prices are high
Step 3. Understand how supply and demand are represented on a graph
One of the most common ways used by economists to describe the relationship between supply and demand is through a 2-dimensional x/y graph. Usually, in this case, the x-axis is designated as "Q", the quantity (quantity) of goods in the market, and the y-axis is designated as "P", the price of the goods. Demand is expressed as a curve that curves from the top left to the bottom right of the graph, and supply is expressed as a curve that curves from bottom left to top right.
The intersection of the supply and demand curves is the point at which the market reaches equilibrium-in other words, the point at which producers produce goods and services at the exact quantities demanded by consumers
Step 4. Understand marginal utility
Marginal utility is the increase in satisfaction that consumers get from consuming one additional unit of a good or service. In very general terms, marginal utility depends on diminishing returns-in other words, each additional unit purchased provides diminishing benefits to the consumer. Gradually, the marginal utility of the good or service diminishes to the point that it is "no longer worth it" for consumers to buy additional units.
For example, let's suppose that a customer feels very hungry. He went to a restaurant and ordered fried rice for IDR 50,000. After eating this hamburger, he still felt a little hungry, so he ordered another portion of fried rice for IDR 50,000. The marginal utility of the second portion of fried rice is slightly below the first portion, because for the price paid, the second portion of fried rice does not provide as much satisfaction as the first portion in terms of eliminating hunger. The consumer decides not to buy the third portion of fried rice because he is already full, and therefore, this third portion has almost no marginal utility for him
Step 5. Understand consumer surplus
Consumer surplus is defined broadly as the difference between the "total value" of a good or the "total value received" by consumers, and the actual price they pay. In other words, if consumers pay for an item less than the item's value to them, consumer surplus represents their "savings".
As a simplified example, let's assume that a consumer is looking for a used car. He budgeted Rp100,000,000 to spend. If he buys a car with all the criteria he wants for $60,000, you can say that he has a consumer surplus of $40,000. In other words, for him the car was "worth" IDR 100,000,000, but in the end he got the car "and" a surplus of IDR 40,000,000 to spend on other things he wanted
Part 2 of 2: Calculating the Consumer Surplus of the Demand and Supply Curves
Step 1. Create an x/y chart to compare prices and quantities
As mentioned above, economists use charts to compare the relationship between supply and demand in the market. Since consumer surplus is calculated according to this relationship, we will use this type of graph in our calculations.
- As mentioned above, set the y-axis as P (price) and the x-axis as Q (quantity of goods).
- The different intervals along the two axes correspond to differences in the respective values of the price intervals for the price (P) axis and the quantity of goods for the quantity (Q) axis.
Step 2. Locate the demand and supply curves for the goods or services being sold
The demand and supply curves-especially in the early examples of consumer surplus-are usually shown as linear equations (straight lines on the graph). Your consumer surplus problem may already have supply and demand curves drawn, or you may have to draw them.
- As explained about the curve in the graph that was given earlier, the demand curve will curve down from the top left, and the supply curve will curve up from the bottom left.
- The demand and supply curves for each good or service will be different, but they must accurately reflect the relationship between demand (in terms of the amount of money a consumer can potentially spend) and supply (in terms of the amount of goods purchased).
Step 3. Find the equilibrium point
As discussed earlier, the equilibrium in the relationship between supply and demand is the point on the graph where the two curves intersect. For example, let's assume that the equilibrium point is at position 15 units at a price point of IDR 50,000/unit.
Step 4. Draw a horizontal line on the price axis (P) at the equilibrium point
Now that you know the equilibrium point, draw a horizontal line starting from that point that intersects perpendicular to the price axis (P). For our example, we know that the point will intersect the price axis at $50.
The area of the triangle between this horizontal line, the vertical line from the price axis (P), and where the demand curve intersects the two, is the area that corresponds to consumer surplus
Step 5. Use the correct equation
Since the triangle associated with consumer surplus is a right triangle (the equilibrium point intersects the price axis (P) at an angle of 90°) and the "area" of the triangle is what you want to calculate, you must know how to calculate the area of a right triangle. -the elbow. The equation is 1/2(base x height) or (base x height)/2.
Step 6. Enter the related numbers
Now that you know the equation and its numbers, you're ready to enter it.
- For our example, the base of the triangle is the quantity demanded at the equilibrium point, which is 15.
- To get the height of the triangle for our example, we have to take the price at the equilibrium point (Rp 50,000) and subtract it from the price point where the demand curve intersects the price axis (P), for example we call it Rp. 120,000. 12,000 - 5,000 = 7,000, therefore we use a height of Rp7,000.
Step 7. Calculate consumer surplus
With the numbers plugged into the equation, you're ready to calculate the result. With the example above, SK = 1/2(15 x Rp7,000) = 1/2 x Rp105,000 = Rp52,500.
