Consumer’s Surplus (Chapter 14)
Daniel N. Tomkins
ECON 3020 – Intermediate Microeconomics
Daniel N. Tomkins
Consumer’s Surplus
Consumer’s Surplus
Gross and Net Consumer’s Surplus
Gross Consumer’s Surplus is is total area under the demand
curve for goods purchased; also called Gross Benefit
Net Consumer’s Surplus is gross consumer’s surplus minus
expenditures
I mean Net Consumer’s Surplus when I say Consumer’s Surplus
How to Interpret Consumer’s Surplus?
The amount the consumer would have been willing to pay for n
goods (how much the value n goods) minus what the consumer
actually paid for n goods
Daniel N. Tomkins
Consumer’s Surplus
Consumer’s Surplus
Gross and Net Consumer’s Surplus
Daniel N. Tomkins
Consumer’s Surplus
Consumer’s Surplus
Other Interpretations of Consumer’s Surplus
As the sum of surplus from each good
Amount of money the consumer would have to be given to agree
to consume 0 of the good
Amount consumer would need to be given to give up all of the good
If the good 2 is money and preferences are quasilinear this is always
an accurate interpretation
If preferences are not quasilinear, this may still be a close
approximation
Daniel N. Tomkins
Consumer’s Surplus
Interpreting Change in Consumer’s Surplus
Why do we care about Consumer’s Surplus?
We are generally more interested in changes in consumer’s surplus
than its absolute level
Changes can result from policy or exogenous changes to economic
conditions
Changes in consumer surplus are an approximation of changes in
welfare
Two affects contributing to welfare loss from price increase
1
Indirect loss causing consumer to consume less of good (T )
2
Direct loss from what is consumed costing more (p00 − p0 )x 00 (R)
Total loss is sum of two effects (T + R)
Daniel N. Tomkins
Consumer’s Surplus
Consumer’s Surplus
Two Effects Contributing to Welfare Loss
Daniel N. Tomkins
Consumer’s Surplus
Compensating and Equivalent Variation
How to measure changes in welfare?
Consumer’s surplus may still be a reasonable approximation of
welfare
It is useful to think of utility in terms of money
How much does a price increase (decrease) hurt (benefit) a
consumer?
How much income would be necessary to compensate the
consumer for a change in consumption?
Daniel N. Tomkins
Consumer’s Surplus
Compensating and Equivalent Variation
How to measure changes in welfare?
How much income would the consumer have to be given (taken)
after the price change to make her as well off as she was before the
price change?
How much income would the consumer be willing to give up
(given) in order for the price change not to take place?
The amount of income that would make the consumer indifferent
between the price change and no price change but different income
Daniel N. Tomkins
Consumer’s Surplus
Compensating and Equivalent Variation
How to measure changes in welfare?
Compensating Variation (CV ) is the change in income
necessary to return the consumer to her original indifference curve
How much income would the consumer have to be given (taken)
after the price change to make her as well off as she was before the
price change?
Equivalent Variation (EV ) is the change in income that is
equivalent to price increase in terms of utility
How much income would the consumer be willing to give up (given)
in order for the price change not to take place?
In general CV and EV are different measure of how “far apart”
two indifference curves are
Daniel N. Tomkins
Consumer’s Surplus
Compensating and Equivalent Variation
What can we say about CV and EV ?
For a price increase, CV is larger than EV
For a price decrease, CV is smaller than EV
CV and EV are equivalent for perfect substitutes and perfect
complements
Is CV or EV a better measure of welfare changes?
Well, I don’t know. . .
Daniel N. Tomkins
Consumer’s Surplus