What is a consumer surplus? (LO6)

Consumer surplus is the difference between the maximum amount a consumer is willing to pay for a good or service and the actual price they pay. In other words, consumer surplus measures the benefit that consumers receive from buying goods at a lower price than what they are willing to pay.

The demand curve is a graphical representation of the relationship between the quantity of a good that consumers are willing to buy and the price of that good. In general, as the price of a good decreases, the quantity demanded by consumers increases, and vice versa. The demand curve has a downward slope, illustrating the inverse relationship between price and quantity demanded.

To calculate consumer surplus, we need information about the maximum amount a consumer is willing to pay for each unit of a good (which is given by the demand curve) and the market price that the consumers actually pay. To find consumer surplus, follow these steps: 1. Plot the demand curve on a graph, with price on the vertical axis and quantity on the horizontal axis. 2. Determine the market price for the good or service, and draw a horizontal line at that price level across the graph. 3. The area between the demand curve and the horizontal line representing the market price is the consumer surplus.

Let's consider an example to illustrate the calculation of consumer surplus. Suppose the demand curve for a good is given by the equation: \(P = 10 - Q\), where \(P\) is the price and \(Q\) is the quantity demanded. Let's assume the market price for this good is $5. 1. Plot the demand curve: To plot the demand curve, we can find points on the curve by plugging in different values for \(Q\) and finding the corresponding value of \(P\). For example, when \(Q = 0\), \(P = 10\). When \(Q = 10\), \(P = 0\). The curve will have a downward slope with an intercept of \(P = 10\). 2. Draw the horizontal line at the market price: In this case, the market price is $5. Draw a horizontal line at this price level across the graph. 3. Calculate consumer surplus: The area between the demand curve and the horizontal line at \(5 is the consumer surplus. This area will form a triangle shape. To find the area of the triangle, we first need to find the base and height of the triangle. The base of the triangle is the quantity where the market price intersects the demand curve. Plugging in the market price (\(P = 5\)) into the demand equation, we get \(5 = 10 - Q\) which implies \(Q = 5\). So, the base of the triangle is 5 units. The height of the triangle is the difference in price from the intercept point to the market price, which is \(10 - 5 = 5\). The area of the triangle (consumer surplus) can be found using the formula: \(\frac{1}{2} × base × height = \frac{1}{2} × 5 × 5 = 12.5\). So, the consumer surplus in this market is \)12.5.