Consumer surplus is the difference between what an individual is willing to pay and the actual price that is paid.
Detailed Explanation:
Have you ever attended an auction? The auctioneer's main task is to find the buyer who is willing to pay the highest price for a product. Most of the time, we don't make purchases at the highest price we're willing to pay. In fact, we would often be willing to pay a little more for a good or service if necessary. We benefit when the price we pay is lower than what we would be willing to pay. Economists refer to this benefit as consumer surplus. The auctioneer aims to eliminate consumer surplus by finding the person who would pay the highest price for a product. However, the auctioneer may not always succeed in eliminating the surplus if the final bid is lower than what the buyer was willing to pay.
To illustrate the concept of consumer surplus, suppose you have three tickets to a Brad Paisley concert. The concert is sold out, and an emergency prevents your family from attending. Joy, Linda, George, Kathy, and Michelle are friends who are interested in purchasing the tickets. Brad Paisley is Michelle’s favorite recording artist, and she is willing to pay $150 for a seat. George, on the other hand, is not a Paisley fan. He would like to attend because he enjoys country music and wants to hang out with the others, but he would not be willing to pay more than $50 for a ticket. Each friend has a different limit. Economists refer to the maximum a buyer is willing to pay for a good or service as the consumer’s “willingness to pay.”
You could sell Michelle a ticket for $150, Joy a ticket for $140, and Linda a ticket for $90. However, to maintain close friendships, you decide to sell your tickets for $90 each. Michelle is thrilled because she is “saving” $60. This is her consumer surplus, which equals the amount she is willing to pay ($150) minus the purchase price ($90). Joy is also happy because her surplus equals $50. Linda is indifferent because the price she is paying equals the price she is willing to pay, resulting in a consumer surplus of $0. The total surplus is the sum of Michelle’s, Joy’s, and Linda’s individual consumer surpluses, which equals $110. Note that if you chose to sell each ticket at each friend’s willingness to pay, the consumer surplus would be $0. (Michelle and Joy might be happy when they purchase the tickets but upset when they learn that Linda only paid $90.)
Consumer surplus measures the social benefit to consumers when the price of a good or service is lower than what many are willing to pay. Assume the graph below represents the demand curve for bottled water. The price is $1.75 (P). You are driving a long distance and feel dehydrated. You must have a drink and are willing to pay $4.00 for a bottle of water, which we will assume is more than anyone else is willing to pay. Point A represents your demand. The actual price you have to pay is $1.75, so you have an individual consumer surplus of $2.25 (willingness to pay minus price paid), illustrated by AC. All buyers who are willing to pay more than the actual price benefit and have a consumer surplus. The individual consumer surplus decreases for each additional buyer. For buyers willing to pay $3.00, their consumer surplus would be $1.25, represented by CF on the graph. Finally, the last buyer would purchase at $1.75 and have no consumer surplus. The total of all individual consumer surpluses is the total consumer surplus, illustrated by the shaded triangle ABC.
Here's a fun video explaining consumer and producer surpluses.
