Consumer Surpluses

Consumer Surpluses

Consumer surplus refers to the difference between the price consumers willingly pay and the required amount payable by consumers, that is, the additional utility people deserve from consumption of a product. (Anderton, 2000)

Demand curve below shows that equilibrium market price for six bottles of mineral water is RM5.00 each. Those who value a bottle of mineral water at RM5.00 or more will buy it and would obtain consumer surpluses. (Case & Fair, 2004) Consumers will buy a product regardless of the increased price from the initial market price only if there is extra utility (consumer surplus) for them and the price does not exceed their budget.

For instance, Bob dropped by a shop and he decided to buy five bottles of mineral water at RM5.00 per bottle. The first bottle was worth RM10 to him, his second RM9, his third RM8, his fourth RM7, and his fifth RM6. A sixth bottle would either worth below RM5.00 to him or simply worthless. The consumer surplus Bob gained by purchasing five bottles of mineral water is RM5.00 for the first bottle, RM4.00 for the second, RM3.00 for the third, RM2.00 for the fourth, and only RM1.00 for the fifth, thus totally RM15.00. (Collinge & Ayers, 2000)

Law of Diminishing Marginal Utility concludes that when Bob consume more of a product, “each additional unit he consumed will yield successively less satisfaction.”(Case & Fair, 2004: 48) He gets consumer surplus for the initial units as he is willing to pay more but not from the sixth bottle as he is not willing to pay more than RM5.00 for the sixth bottle. (Case & Fair, 2004) In short, as Bob pays the price of the last unit for all initial units consumed, he enjoys consumer surpluses for the units bought above what he actually pays for a product.

Factors that affect the demand for a product

Price of Substitute Goods

Figure 1.1

One of the main factors that determines the demand for a product is price of substitutes goods with similar functionalities and characteristics. (Anderton, 2000) The increase in price of substitute of hamburger, which is the pizza leads to a situation where consumers tend to demand less for pizza and opt for Mac Donald’s hamburgers (Big Mac). Rational consumers would preferably choose a cheaper product with similar quality. The one of the best bargain usually highly demanded. Therefore, demand for the product (Hamburgers) would increase when price of substitute goods increase, ceteris paribus and there will be a shift of the demand curve of hamburgers to the right and vice versa (Figure 1.1).

Price of Complementary Goods

Figure 1.2

Complements are goods that ‘go together’ with the product itself. Their price significantly determines the demand for a product. (Case & Fair, 2004) According to Figure 1.2, increase in the price of complementary goods (Vanilla Coke) results in less demand for the product itself (Hamburgers). When the price of complements of hamburgers, which is the Vanilla Coke, increased, the demand for both Vanilla Coke and hamburger will decrease, ceteris paribus, “as both of these goods normally purchased along or in conjunction with each other”. (D. Rohlf, Jr, 1999) The increase in price of complementary goods inversely proportional to consumer surplus for customers, thus, there will be a shift of the demand curve of hamburgers to the left.

Increase in Consumers’ Income

Moreover, income of consumers has direct effect towards the demand for a product as “consumers’ incomes influence their ability to purchase goods and services, that is, their purchasing power.”(D. Rohlf, Jr, 1999: 71) If the demand for a good falls when income falls, the good is called a normal good, for example, soap. On the other hand, if the demand for a good rises when income falls, the good is called as inferior good, for instance, bus rides. (Mankiw, 2004)

Figure 1.3

Figure 1.3 illustrates that when there is an increase in income of Bob, naturally, Bob would demand more on natural goods such as the soap and demand less on inferior goods such as bus rides. If there is a fall in Bob’s income, Bob would be constrained by the limited income he has and had to reduce his demand for soap and opt for cheaper transportation, which is the bus ride. Thus, the demand for normal goods (soap) would fall and demand for inferior