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1.1 Consumer Surplus
Consumer’s surplus = What a consumer is ready to pay – What he actually pays.
Lets understand this with example.
In the given chart, price of the commodity is decided at ‘P’ and thus resultant quantity demanded is ‘OQ’.
If we see at the consumer demanding first unit of the commodity, he is ready to pay the price ‘OY’ but he ends up paying ‘OP’ as that is the price decided for the commodity.
The difference ‘PY’ is the benefit which this consumer saves and is termed as consumer surplus i.e. profit gained by the consumer.
To get the total consumer surplus for this commodity we can add up the benefit of all the consumers, that is the shaded area ‘PRY’.
1.1.1 Limitations of Consumer Surplus
- Consumer’s surplus cannot be measured precisely – because it is difficult to measure the price each consumer will be ready to pay.
- In the case of necessaries, the marginal utilities of the earlier units are infinitely large i.e. consumer can pay a very high amount for such initial unit of necessary commodity. In such case the consumer’s surplus is always infinite.
- The consumer’s surplus derived from a commodity is affected by the availability of substitutes.
- There is no simple rule for deriving the utility scale of articles which are used for their prestige value (e.g., diamonds).
- Consumer’s surplus cannot be measured in terms of money because the marginal utility of money changes as purchases are made and the consumer’s stock of money diminishes. (Marshall assumed that the marginal utility of money remains constant. But this assumption is unrealistic).
- The concept can be accepted only if it is assumed that utility can be measured in terms of money or otherwise. Many modern economists believe that this cannot be done.