How does consumer surplus explain why markets are efficient?

In a market system, things get settled after combining the individual’s preferences of both sides that is demand and supply side. After combining the individual preferences we get the market equilibrium at which market work most efficiently. For the markets to work most efficiently they have to meet two conditions: that the demand curve must represent the consumers’ full readiness to pay, and the supply curve represents the full cost used in production. If these two conditions met then only those goods will be produced in the market for which consumer benefits and cost of production are almost equal. This will increases the total benefit that consumer and producer share. 

The total benefit which is also called total surplus is divided into two parts in which one is consumer surplus and the other is producer surplus. Now we will see what the consumer surplus is and how we can achieve it in order to make the market work efficiently. 

Consumer Surplus: 

The part of the total surplus that is enjoyed by consumers is called consumer surplus. Consumer surplus is the difference between the maximum amount of money that the consumers are willing to pay and the actual amount of money that they pay.  

The maximum amount that the consumer is ready to pay for a particular good depends on the opportunity cost of the buyer that how much he is willing to let go of other products to get this one. Like if Sarah wants to spend a maximum of Rs.40,000 to purchase a mobile phone and if she has to spend more than that even Rs.1000 more then she would have to let go of other good for that. But, if the market price of the mobile she wants to purchase is Rs. 30,000 then this difference between maximum she wants to spend and actual market price that is Rs. 10,000 is her consumer surplus.    

Consumer Surplus and Demand Curve: 

The good thing about the markets is that even if consumers are willing to spend more still they have to pay market equilibrium price. Take an example of buyers as shown in the table below who want to buy a milk carton. 

Consumers Maximum price willing to payEquilibrium PriceConsumer Surplus
AhmedRs.12Rs.9Rs.3
AliRs.11Rs.9Rs.2
SarahRs.10Rs.9Rs.1
FatimaRs.9Rs.9Rs.0

As the maximum price consumer want to pay also help us to understand the phenomena of the demand curve as well. As we see as the price decrease more buyers are able and willing to purchase. If the market or equilibrium price would be Rs. 13 then only Ahmed will be able to purchase it but as the price decrease to Rs. 10 then Ahmed, Ali, and Sarah all three are willing to purchase it. So as the price decrease more buyers are willing to purchase which is the law of demand. 

Graphical Analysis: 

If we take the consumer surplus of each buyer at the individual level and combined them we can get the market total consumer surplus. This is also shown below in graph no.1. The consumer surplus of all buyers collectively is represented by a triangular shaded area and could be found through using the formula of area of a triangle (1/2hb ).

Graph no.1

From graph no.2, we can also tell that as more the buyer is willing to pay, the higher would be his or her consumer surplus. Like in the case of Ahmed as he wants to pay Rs.12 his consumer surplus would be highest amongst all the buyers and Fatima’s consumer surplus would be zero because the maximum she is willing to pay is Rs. 9 which is the equilibrium price. In graph no.2, we can see Ali’s consumer surplus which is the green shaded area under the price Rs.11 that is less than Ahmed’s but higher than Sarah’s. 

Graph no.2

Effect of Equilibrium Price on Consumer Surplus: 

It’s clear from the graph no.3 that as the market-clearing price or equilibrium price goes up the consumer surplus decrease and as it moves down the consumer surplus increase. In the graph below, as the equilibrium price shifts from Rs.9 to Rs.7 the consumer surplus becomes large. 

Graph no.3

Also Read: How price ceiling and price floors work and why they cause a shortage or surplus in the market?