Consumption
2. LAW OF EQUI-MARGINAL UTILITY
2.7. CONSUMER'S SURPLUS
2. Scientific: The indifference curve analysis is based on the principle of marginal rate of substitution. This concept is more superior to the law of marginal utility, because it considers two goods together and expresses it as ratio of physical units.
3. Production: The indifference technique is made use of in finding out the producers equilibrium. Just as the indifference curve is for the consumer, the equal product curve is for the producer.
4. Exchange: In the field of exchange, indifference curves can be used to determine the position of equilibrium when two individuals are entering into a market. The technique has shown the manner in which exchange can take place between two parties where their preferences of the goods are given.
5. Taxation: The principle of indifference curve technique is applied in the field of taxation in public finance. Which is used to judge the welfare effects of a direct and indirect tax on the individual.
6. Savings: This technique can also be utilized in the field of savings. The indifference curves shows that the preference of an individual between present and future goods. His decision to save depends on desire on present goods over future goods. It is also used in the field of index numbers to show the standard of living of the consumer in two different periods with different levels.
maximum price the consumer is willing to pay for the commodity and the actual market price charged for it. Consumer's surplus may also be defined as "the difference between the total amount of money the consumer would have been willing to pay for a quantity of a commodity and the amount he actually had to pay for it".
The doctrine of consumer surplus is based on the law of diminishing marginal utility, where the utility of the consumer gradually decreases as he keeps on increasing the demand for a commodity.
The consumer surplus an be measured through a formula.
Consumer's Surplus = Total Utility – (Price × Quantity) In symbolic terms: Consumer's Surplus (CS) = TU – (P × Q)
Where TU = total utility
Q = quantity if the commodity P = Price.
Alternatively consumer's surplus = Price prepared to pay – Actual price paid.
Unit of Marginal utility market price Consumer
commodity MU Rs surplus = Prep
Z to pay –
Actual mkt. price
1 50 20 30
2 40 20 20
3 32 20 12
4 20 20 0
total 4 units 142 80 62
thus CS = TU – (P × Q)
= 142 – (20 × 4)
= 62
The concept of consumer's surplus is explained in the above schedule. The price of commodity z is assumed to be Rs 20 per unit. By buying the first unit the consumer obtains 50 units of marginal utility. The surplus which he willing to pay is Rs 30.
When he consumes the second unit. The price remaining the same, the consumer's marginal utility is 40. The consumer surplus here is Rs 30. It is thus seen here that the consumer surplus for the
Diagrammatic illustration
commodity gradually goes down and when he buys the 4 units the marginal utility is equal to the price paid, the consumer surplus is 0. Hence the consumer would not progress to buy commodities beyond this point. It can also be noticed that the concept of consumer surplus behaves in a similar fashion as the law of diminishing utility.
In the figure price and marginal utility is measure on the y axis and units of the commodity is measured on the x axis. MU is the marginal utility curve which slopes downward. At OP price,OQ units are purchased. The marginal utility of OQ units bought is equal to OP price. The total money paid is OP × OQ = OPQR.
The total utility derived = OMRQ. Thus consumer's surplus = OMRQ – OPRQ = MRP.
Assumptions
There are certain basic assumptions which underlie the concept of consumer surplus.
● The consumer's surplus is based on the cardinal utility which measures utility in terms of units.
● The concept of consumer's surplus involves ceteris paribus assumption underlying the law of diminishing marginal utility.
● Since the concept is derived on the basis of demand for the commodity, all assumptions made for the demand analysis
are equally applicable here. In drawing the demand curve we assume that the tastes, preferences, of the consumer remain constant and the study is made only with reference to change in price of a particular commodity.
● The utility of a commodity depends on the quantity of commodity alone. Each commodity is treated alone.
Criticisms
● Economist argued that the concept is purely subjective, and to measure this is impossible.
● Critics cannot reconcile with the assumption of Marshall that the commodity has no substitutes. When there are lots of substitutes for the consumer to choose, there is no question of what the consumer is willing to pay rather than go with out it.
● It is believed that when a consumer spends money on a particular commodity his stock of money will get reduced and correspondingly his marginal utility of money will go up.
● It was felt the concept of consumer surplus is meaning less and does not apply to necessaries, because in case of necessaries a consumer derives infinite utility and would be willing to pay anything he can rather than go without it.
● The concept cannot be precisely measured.
● Prof Nicholson felt the doctrine was hypothetical. In case of articles like diamonds possessing scarcity and value, consumer's surplus seemed to be unsubstantial. Thus it was felt the concept was invalid in case of luxuries goods.
Importance of the Concept
● The concept of consumer's surplus is useful in clarifying the paradox of value by distinguishing the value-in-use and value-in-exchange. Consumer surplus depends on the differ- ence between total utility and price and price depends on marginal utility. A high consumer surplus thus implies value- in-use as compared to the value-in exchange of a commodity.
In articles salt, water the value-in use more compared to value-in exchange, but in case diamonds value-in exchange is greater that its use.
● It is useful in determining the price of a commodity, by analysing the preference of the consumer, his likes and dislikes, the price of the commodity can be altered.
● This concept is widely accepted in welfare economics. As it helps to compare the effects of a given change in the price of any commodity on different classes of people.
● The concept of consumer surplus is useful in international trade.
● It is of greater significance to the exchequer in determining indirect taxation. Taxes on commodities can be changed depending on their consumer surplus.