EFA (35): Consumer surplus

We all know the feeling, though maybe not as often as we would like to. We find something in a shop (or online) that we would really like to buy — let's say a pair of jeans — and the price is much lower than we had expected.

In such situations, we are delighted to have found a bargain. And we might just fleetingly think that, actually, we would have been prepared to pay more for this pair of jeans.

Economists have a special name for this extra benefit that we get as consumers when we buy something that is worth more to us than the price we pay. This is called "consumer surplus", and it is the subject of the 35th item of our Economics for Amateurs (EFA) series.

Typically, consumer surplus arises because all consumers are charged the same price for a particular good, but some would be willing to pay more. (Presumably, nobody intentionally pays more for a good than it is worth to them, although we have all done so unintentionally from time to time.)

The converse of the consumer surplus is the producer surplus. This reflects the fact that firms would have been willing to sell some units of a particular good at a lower price than the one they actually charge.

The amount of both the consumer and producer surpluses can be illustrated simply by means of a graph using standard supply and demand curves (see here for an example).

These two surpluses are the "gains from trade": they show how much better off consumers and producers are by engaging in trade than by not doing so.

Naturally, producers would like to expropriate as much of the total surplus for themselves as possible. Ideally, they would like to charge each consumer exactly the price he or she is willing to pay.

In practice, this is impossible, although we do see cases of "differential pricing" (for example, in the different prices of hardback and paperback versions of books). For a discussion of differential pricing, see this recent article in The Economist.

Problems arise when we move away from a situation of perfectly competitive markets — in which individual buyers and sellers have no influence on market prices — and introduce complications such as monopoly power of firms, or government taxes.

In such cases, the total of the consumer and producer surplus together is reduced, which represents a loss of benefit to society. This loss is known as a "deadweight loss", which can also be illustrated graphically (see here).