Consumer Surplus Formula

'Savings' received by the consumers

How to calculate Consumer Surplus

Consumer surplus is an economic measurement to calculate the benefit (i.e. surplus) of consumers are willing to pay for a good or service versus its market price. The consumer surplus formula is based on an economic theory of marginal utility. This theory explains that spending behavior varies with the preferences of individuals. Since different people are willing to spend differently on a given good or service, a surplus is created. It is used across a wide range of corporate finance careers.

 

Consumer Surplus Experience

 

Consumer Surplus formula

There is an economic formula that is used to calculate the consumer surplus (i.e. benefit) by taking the difference of the highest they would pay and the actual price they pay.

Here is the formula for consumer surplus:

Consumer Surplus = Maximum Price Willing – Actual Price

 

consumer surplus formula

 

In Practice

Here is an example to illustrate the point. A shopper is determined to buy a $1,000 laptop. As he skims through various electronics stores, he finds one for $600 that meets all his needs, saving $400. The $400 is his consumer surplus, which he can further spend on other goods or services.

 

Consumer surplus at a larger scale

Demand curves are highly valuable in measuring consumer surplus in terms of the market as a whole. A demand curve on a demand-supply graph depicts the relationship between the price of a product, and the quantity of the product demanded at that price. Due to the law of diminishing marginal utility, the demand curve is downward sloping. The shaded part in the illustrated graph presented below represents the consumer surplus.

 

Extended consumer surplus formula

Consumer Surplus = Qd x ΔP

Qd = Quantity demanded at equilibrium, where demand and supply is equal

ΔP = Pmax – Pd

Pmax = Price the buyer is willing to pay

Pd = Price at equilibrium, where demand and supply are equal

 

Producer surplus

On the other side of the equation is the producer surplus.  As you will notice in the chart above, there is another economic metric called the producer surplus which is the difference between the minimum price a producer would accept for goods/services and the price they receive.

In a perfect world, there may be an equilibrium price where both consumers and producers have a surplus.

 

Practical applications

In a theoretical market for bottled water, a customer is willing to pay $10 for the bottled water, which is the highest amongst other customers. Most customers are only willing to pay $5, which is coincidentally the price that is set when demand meets supply exactly. At $5, 20 bottles are supplied, and consumer surplus is $100. This means that -shared amongst the customers who bought the 20 bottles of water- there are $100 in savings that can go towards other purchases.

 

More economic resources

We hope this has been a helpful guide on the consumer surplus formula.  To learn about more important economic principles, please see our related articles and guides below: