Question

Answer each of the following questions about demand and consumer surplus

a. What is consumer surplus, and how is it measured?

b. What is the relationship between the demand curve and the willingness to pay?

c. Other things equal, what happens to consumer surplus if the price of a good falls? Why? Illustrate using a demand curve.

d. In what way does the demand curve represent the benefit consumers receive from participating in a market? In addition to the demand curve, what else must be considered to determine consumer surplus?

Answer 1

a) Consumer surplus is the benfit that consumer earn in the market. In other words consumer surplus is the difference between the willingness to pay of consumer and actual price paid by the consumer. In the figure below area in yellow is the consumer surplus. It can be calculated by two methods:

• As it is a shape of triangle. So area of triangle formula can be use: Consumer surplus= 1/2(base)(height)= 1/2(Q*-0)(P-P*)
• By integrating demand equation with respect to Q where lower limit is 0 and upper limit is Q* and then subtract remaining area below yellow(P* x Q*)

b) Demand curve is the locus of all the point which shows different combination of price and quantity demand by consumer. It generally shows the maximum amount that consumer is ready to pay for different quantity. This maximum amount is known as willingness to pay of consumer. Like in the above figure for Q* consumer ready to pay P* which is the maximum amount consumer ready to pay.

c) In the figure below as the price decreases from P* to P** the consumer surplus increases from area in yellow to new consumer surplus which include area in yellow as well as area in orange. It is so because for quantity less than Q** a consumer willingness is same but the actual price paid them decreases which raises their benefit.

d) For determining consumer surplus, the market price should be included. It help to determine consumer surplus because consumer surplus can be calculated when actual price is given and the actual price is less than what consumer are willing to pay. The area between demand curve and actual price line is the consumer surplus.