We begin consumer surplus by looking at the demand side. Consumer surplus refers to the excess value a buyer receives from the purchase of a product, as they perceive it. Remember, the demand curve reflects the value, or the willingness to pay, that the buyer has for a particular product. This willingness to pay is unique to each individual buyer, based on their income, preferences, and other assorted factors.
When a consumer purchases a product, If the willingness to pay of the consumer is greater than the price of the product, then the consumer purchases. In that case, they'll receive consumer surplus, or excess value. Think of a product that you enjoy purchasing, and the willingness to pay that you have.
have of that product. Every consumer has a reservation price. This just reflects the highest price or the maximum price that you're willing to pay for that product.
You would never pay over that price for the product, even though you would never pay over that you value it, because the willingness to pay, or your reservation price, reflects that maximum value that you receive. When we measure consumer surplus, this value is important because consumer surplus is only measured when the consumer purchases the product. So how do we actually measure it?
We use the demand curve to reflect the willingness to pay. Remember, the demand curve gives us the quantity demanded at each individual price. So it allows us to see not only the willingness to pay of the buyer, but also relative to the price, we can determine how much excess value.
In other words, what's the most I'm willing to pay for a given quantity? Or how much do I want to buy at each price? The demand curve helps us to answer both of those questions.
So if the demand curve reflects the willingness to pay of the buyer or the maximum value that the buyer receives, the consumer surplus or the excess value, is the difference between what they're willing to pay, or their reservation price, minus the price they actually have to pay. So for example, let's suppose that you're going to go and buy a new pair of jeans, and the maximum price you're willing to pay for that pair of jeans is $50. But you go into the store, and you see that they're having a sale, and you only have to pay $40 for the product. Because the price that you're willing to pay is greater than the price that you're willing to pay. price that you have to pay, you're going to receive excess value when you purchase that product.
The amount of excess value, we follow this formula. The willingness to pay minus the price paid gives us the consumer surplus. In this case, because you were willing to pay $50 but only had to pay $40, you receive an excess value of 10. Now what is that 10 measuring?
The 10 is measuring sort of an excess happiness. You're willing to pay $50 but you only had to pay 40. No one's giving you an extra $10, but that's 10 extra dollars you are keeping in your pocket that you can use to buy something else. And so that excess value refers to the excess value that you get to keep as a consumer. Now, what would happen if instead of $40 price, what if instead you went in and you saw that the price of jeans had actually increased to $60?
Now we can still follow that same formula, the willingness to pay. minus the price actually paid. What we see now is 50 minus 10 would give us a negative consumer surplus. This can't happen. Consumer surplus can never be negative.
Consumer surplus must be greater or equal to zero. In other words, if the price that you have to pay is greater than your willingness to pay, you don't actually purchase the product. So you can never have a negative consumer surplus. What about graphically? Let's go back to a demand curve that we have that we looked at in our model of supply and demand with quantity on our X price on our Y.
Remember at each individual price along our demand curve it gives us a quantity demanded. In order to measure consumer surplus, we know that we can follow our formula as the difference between the willingness to pay minus the price that's actually paid. Remember, our demand curve reflects that willingness to pay. point on our demand curve it reflects the willingness to pay of the respective quantity relative to each price.
In other words at this particular price level let's call it P-not, the consumer is willing to purchase Q-not quantity of that good. We could look at the price and quantity combination for each. If the equilibrium price, that is the price that we are actually paying, so let's call this the price that's paid, if the equilibrium price, or the price we're paying, is less than the price that reflects the willingness to pay, then the consumer purchases the product.
So if, for example, we look at a price of P naught, that price P naught is greater than the price P1. and so the consumer purchases the first Q naught unit. The excess value they receive from the consumption of that unit is the difference between the price they're willing to pay and the price they actually have to pay. This height difference here reflects the consumer surplus for that unit. But as we go down to additional prices, we see that there's still excess value for each one of the additional units that the consumer is purchasing.
all the way up until the equilibrium quantity that they purchased Q1. So, if the consumer goes all the way up to this quantity Q1, we can actually add up the values of consumer surplus all the way down. And the consumer will continue to purchase until the willingness to pay is exactly equal to the price. We call this the point where they become the marginal buyer. That is, they've reached the price that's exactly equal to their willingness to pay.
Or, another way to put it, is that's the last price that they would purchase. If the price went any higher, they would no longer purchase the product. Or, if we went beyond Q1 units and extended the price out like this, their willingness to pay falls below the price.
And so this consumer, at a price of Q1, would never consume more than Q1 units. So graphically, we can actually measure consumer surplus by looking at the area under our demand curve, but above our price, up to that quantity that the consumer purchases. So all of this area here reflects the consumer surplus of this individual buyer. The reason we're looking at this is we know that they will buy up to Q1 units, where the willingness to pay is exactly equal to the price, and they will always purchase as long as their willingness to pay is greater than the price. So this triangle reflects the consumer surplus for this individual buyer.
Graphically, we can find the area of this triangle. If you remember from your 7th grade geometry class, we can find 1 half base times height in order to find the area of that triangle, which will give us the numerical value of consumer surplus.