Definition: Consumer Surplus is an economic measurement that depicts consumer satisfaction by calculating the difference between the market price of a good and what consumers are willing and able to pay for it. In other words, consumer surplus measures the value that consumers have for a good above or below the current market price.
What Does Consumer Surplus Mean?
A consumer surplus occurs when consumers are willing to pay more than the market price for a good. This is typically caused by an increase in demand that isn’t matched with an equal increase in supply or simply a decrease in supply. This concept is also closely tied with price elasticity.
This measurement is widely used by economists and businesses in order to facilitate more efficient knowledge of the markets. Businesses that have a large degree of control over their pricing practices try to maximize their profits by figuring out the highest price a consumer is willing to pay for a good and still be satisfied with it. Thus, they keep their customers happy and maximize profits at the same time.
Let’s look at an example.
Jenny is the CEO of the only commercial space-travel company offering flights to Mars. She wants to maximize the profits on each flight, as space travel is still exceedingly expensive. How does she do that? First, she looks at the market data, and sees that a flight to Mars on her ship costs each consumer $50,000. However, she sees every day that consumers are willing and able to pay much more than $50,000 for that once-in-a-lifetime trip to another planet, so she asks her economists to conduct a study to figure out how much each consumer is willing to pay for her product.
The economists conduct market surveys and to figure out consumers’ ability and willingness to pay for all five consumers of her product. Consumer 1 is willing to pay $200,000, Consumer 2 is willing to pay $175,000, Consumer 3 is willing to pay $100,000, Consumer 4 is willing to pay $75,000, and Consumer 5 is willing to pay $50,000. The economists show this data to Jenny indicating that there is an average surplus of $75,000.
Thus, she decides to raise the price to $125,000. Since she is the only company traveling to Mars, she has absolute pricing power and doesn’t have to worry about competition undercutting her.
This measurement is a powerful tool for economists and businesses that have pricing power because it shows the willingness to pay for each individual consumer above and beyond the price in a market. It is a measure of the value that consumers hold for an item, regardless of the market price.