Formula to Calculate Consumer Benefit
The formula for consumer surplus is an economic formula that is used to calculate the consumer benefit by deducting the actual price that the consumer has paid from the maximum price the consumer is willing to pay (for a single unit of product).
Consumer surplus is a point where the demand and supply of a product or service meets and it can be calculated by reducing the maximum price a customer wishes to pay for a product or service for buying purposes and the actual price he or she ends up buying or in simple words the difference between customers willingness to pay less the market price.
Now, the consumer surplus formula is extended for the market as a whole i.e. multiple consumers. The area of ΔRPS in the illustrated graph shown below represents the consumer surplus which is bounded by the downward sloping demand curve, the axis for the price and the horizontal line drawn parallel to abscissa for demand at equilibrium.
In the above graph, point R and P represents the maximum price willing to pay and market price respectively on the ordinate. On the other hand, point T or S corresponds to the quantity demanded at equilibrium. Consequently, the consumer surplus equation can be expressed as,
(Since OT || PS)
Step by Step Calculation of Consumer Surplus
The first formula of consumer surplus for one unit of product can be calculated in the following three simple steps:
- Step 1: Firstly, assess the utility of the product for the consumer based on which the highest price that the consumer is willing to pay can be arrived at.
- Step 2: Now, figure out the actual price of the product in the market.
- Step 3: Finally, the consumer surplus is arrived at by deducting the value derived in Step 2 from the value in Step 1 as shown below.
On the other hand, the following four steps help in the computation of the extended formula for consumer surplus which is more popularly used:
- Step 1: Firstly, draw the Supply and Demand curves with quantity on the abscissa and price on the ordinate.
- Step 2: Now, locate the market price which is the equilibrium price. According to the law of supply and demand, the market price is the point of intersection between the supply and the demand curve.
- Step 3: Now, draw a horizontal line between the market equilibrium price and the ordinate.
- Step 4: Finally, calculate the area of the upper triangle (ΔRPS in the above diagram). Consequently, calculation of consumer surplus can be done by multiplying the base (RP) and the height (PS) and then dividing by 2.
Let us take the example of a single customer and a single product. So, let us assume that a customer decides to buy a mobile with a 16GB RAM and a 5.5″ screen and is willing to pay up to $1,200 for that. Now, while browsing through various electronics stores, the customer discovers a store that offers all the criteria exactly at $900.
- Maximum price willing to pay = $1,200
- Actual price = $900
- Consequently, using the first formula we get, Consumer Surplus = $1,200 – $900
- Consumer Surplus = $300
Therefore, the customer saved $300 as a consumer surplus which he/she can spend on some other goods or services.
Let us take another example wherein a customer is willing to pay $20 for the packed food item and this is the highest price among the customers. In fact, the majority of the customers are willing to pay only $10, which is eventually the market price (demand and supply curves meet). Now at $10, the total food packets demanded is 30 (equilibrium demand).
- Demand quantity at equilibrium = 30 units
- Maximum price willing to pay – Market price = $20 – $10 = $10
- Consequently, using the extended formula we get,
- Consumer Surplus = ½ * 30 * $10
- Consumer Surplus = $150
Now, let us take an example of consumer surplus with the demand function represented as QD = -0.08x + 80 and the supply function represented as QS=0.08x where x is the quantity demanded in kg.
In the below-given template is the data used for the calculation of the consumer surplus.
From the above data, we have collected the data required for the calculation of consumer surplus.
In the below given excel template
So the calculation of Consumer Surplus will be-
Consumer Surplus Calculator
You can use the following Consumer Surplus Calculator.
|Consumer Surplus Formula =||Maximum Price Willing to Pay – Actual Price|
|0 – 0 =||0|
Relevance and Uses
- It is very important to have a clear understanding of the concept as it can help in taking business decisions associated with the price-output setting, value pricing and price discrimination under the purview of various marketing strategies.
- It has to be accepted that there is a trade-off between consumer surplus and revenue generated. If the emphasis is laid on increasing revenue through an increase in the product price, then the consumer surplus will deteriorate as a result.
- The aforementioned scenario may result in higher income but accompanied by a relative weakening of the firm’s position among competitors with identical products. As such, one has to be very cautious while fixing the price in order to ensure that the consumer surplus is not impacted severely.
This has been a guide to Consumer Surplus Formula. Here we learn how to calculate the consumer surplus along with some practical examples, a calculator and a downloadable excel template. You can learn more about Excel Modeling from the following articles –