How To Calculate Consumer Surplus (With Examples)

Understanding economic supply and demand provides valuable insight into any given market. You’ve probably seen a basic demand-supply graph used to illustrate the relationship between a product’s market price and the quantity demanded by consumers.

Consumer surplus and producer surplus are important pieces of the equation. Markets tend to fluctuate, especially because consumers are able or willing to spend at different price points for any given product or service. This is where a surplus is created.

Key Takeaways:

• To calculate consumer surplus you need to know the difference between the cost consumers are willing to pay for a product or service and the actual market price.

To calculate extended consumer surplus you need to know the difference between the price the consumer is willing to pay and the price at equilibrium on the supply and demand curve, then multiply this by 0.5 the quantity at equilibrium where supply and demand are equal.

Producer surplus is the difference between the minimum price a producer is willing to accept for their goods or services and the final price they receive.

• A social surplus is the sum of consumer surplus and producer surplus.

• Price floors set a minimum on a price. Price ceilings set a maximum on a price. Both are tools enforced by governments when they feel their benefits outweigh their market inefficiencies.

What Is Consumer Surplus?

Based on the economic theory of marginal utility, consumer surplus is an economic measurement calculating the excess cost that consumers are willing to pay for a product or service in comparison to the actual market price.

How to Calculate Consumer Surplus

When looking at a demand-supply graph, the demand curve is always going to be sloping downward due to the law of diminished marginal utility. We can measure consumer surplus with the following basic formula:

In our earlier example with the television, we can see that consumer surplus equals $1,300 minus $950 to give us a total of $350 for our surplus.

On a larger scale, we can use an extended consumer surplus formula:

• Qd = the quantity at equilibrium where supply and demand are equal

• ΔP = Pmax – Pd

• Pmax = the price a consumer is willing to pay

• Pd = the price at equilibrium where supply and demand are equal

If this formula looks vaguely familiar, that’s because we’re actually solving for the area of the consumer surplus triangle on a demand-supply graph. As a reminder, the formula to calculate the area of a triangle is (½) x base x-height.

But then why does the consumer surplus formula require subtraction?

Good question. Keep in mind that the height of the triangle we’re solving for isn’t starting at 0 on the graph. Instead, it’s determined by the distance from the equilibrium price to the point where the demand curve intersects with the vertical axis. Because of this, our height is going to be the difference between those two points rather than the value of the topmost point on the axis.

Let’s take a look at an example using the extended formula.

What Is Producer Surplus?

Supply and demand are all about balance, so the opposite side of the equation results in a producer surplus, which is the difference between the minimum price a producer is willing to accept for their goods or services and the final price they receive. A surplus happens when market prices exceed the lowest price point that a producer will accept.

Let’s look at an example to better understand producer surplus.

How to Calculate Producer Surplus

When looking at a demand-supply graph, the supply curve is always going to be sloping upward due to the law of increasing returns. We can calculate producer surplus with this formula:

Understandably, producers can’t earn a profit if they aren’t able to recoup at least the marginal cost they spent to produce and transport their products. A free market has this natural push-pull effect that prevents either the consumer or the producer from fully dictating price points.

However, some businesses are able to take advantage of price discrimination in order to increase company profits.

Price Discrimination

This selling strategy involves charging different prices for the same goods or services based on the business’s estimation of the maximum amount they think the customer is willing to pay.

For example, suppose you’re looking at renting a house on the beach for a week. In that case, the exact same house is going to cost a lot more if you’re renting during peak tourist season versus the off-season when the renter is desperately trying to prevent the house from sitting empty.

Most brand-name goods know that there’s power in a name and people are willing to pay much more to be “on brand” rather than buy a cheaper, almost identical alternative that’s lacking a famous logo.

Airlines are also notorious for price discrimination. They know that people are willing to pay more for convenience.

Because there’s less of a demand for early morning and late-night flights, the airline is able to price fares differently depending on the time of day, even though the cost of flying and fueling a plane from Destination A to Destination B isn’t going to change. This is called the elasticity of demand.

What Is Social Surplus?

Also referred to as economic surplus or total surplus, a social surplus is the sum of consumer surplus and producer surplus. When looking at a demand-supply graph, the social surplus is the total area between the supply curve, the demand curve, and the point of equilibrium.

A deadweight loss, which occurs when the economy is producing at an inefficient quantity, is the loss in total surplus.

When the market is operating at optimal efficiency, it’s impossible to increase consumer surplus without reducing producer surplus, and it’s also impossible to improve producer surplus without lowering consumer surplus.

Total surplus is larger at equilibrium quantity and price than it would be at any other quantity and price.

How Do Price Floors and Price Ceilings Affect the Market?

A healthy market is able to adapt and settle naturally on an equilibrium point that balances price and quantity. Imposing a price floor or ceiling prevents the market from adjusting to its ideal point of equilibrium and maximum efficiency while also transferring some of the consumer surplus to producers and vice-versa.

A price ceiling is a maximum price a producer is allowed to charge consumers in exchange for a good or service.

The government’s impact on the drug market is an excellent example of price ceilings. Let’s say that a pharmaceutical company created a new life-saving drug. The market-price equilibrium, if left to the free market without any restrictions, would be $800, with an expected 50,000 people using the drug per month.

But the government wants to make the drug more affordable, so it imposes a price ceiling at $500.

So, what happens?

First, the pharmaceutical company is going to produce a lower amount of product. Their supply is going to reflect the price ceiling line on the graph instead of the market equilibrium point. This reduces the social surplus and increases deadweight loss. Basically, money is being discarded without benefitting anyone.

In addition, some of the producer surpluses end up being transferred to consumers, which is why consumers largely favor price ceilings. However, the gain to consumers is less than the loss to producers, aka still a deadweight loss. The market is not operating as efficiently as it could be.

A price floor is the lowest price that can legally be paid for goods or services.

For example, let’s say the city government is concerned about a historical theater going out of business. It has a long tradition of providing entertainment to the community giving local musicians and actors a place to perform. The government decides to set a minimum ticket price at $10 for performances.

As a result of the higher price per ticket, demand for tickets falls. The theater had been selling 1,500 tickets for $7 at the equilibrium point, but now they’re selling 1,100 for $10. Although the price floor caused some of the consumer surplus to be transferred to the producer, which is why producers often favor price floors, the market is still looking at an overall deadweight loss.

Frequently Asked Questions

1. Is there any benefit in understanding consumer surplus?

Yes, there is a great benefit to understanding consumer surplus. If you are a consumer, knowing about consumer surplus empowers you to make smart long term definitions. For example, if you buy a product at a price less than you’re willing to spend, you know you have a consumer surplus. This concept can guide you to a decision to either spend or save that “surplus” based on your needs and wants.

2. Who is affected by consumer surplus?

Consumers and producers are affected by consumer surplus. A consumer is obviously affected by a consumer surplus because it provides a concept on how to approach paying for goods or services. Similarly, a producer needs to consider the difference in which they are willing to set a price against what is the greatest amount of goods or services they can sell. This in part is based on the where the consumer surplus ends at equilibrium.

Final Thoughts

The market is fluid. When it’s allowed to operate freely, consumers and producers tend to push and pull until equilibrium is reached and the market is able to regulate its supply and demand with maximum efficiency.

Understanding the basics of supply and demand; consumer, producer, and social surplus; price discrimination; deadweight loss; price ceilings; and price floors are critical to making comprehensive business decisions about quantity and pricing.

Author

Chris Kolmar

Chris Kolmar is a co-founder of Zippia and the editor-in-chief of the Zippia career advice blog. He has hired over 50 people in his career, been hired five times, and wants to help you land your next job. His research has been featured on the New York Times, Thrillist, VOX, The Atlantic, and a host of local news. More recently, he's been quoted on USA Today, BusinessInsider, and CNBC.