CHAPTER: CONSUMERS, PRODUCERS, AND THE EFFICIENCY MARKETS
Many people love shopping. Personally, I hate it. But everyone likes a bargain—buying a good they value highly at a low price. And this goes to the heart of “consumer surplus,” the first building block of welfare economics.
One student asks if a person buying a new car exhibits consumer surplus, and how this could be true if one never knows how much the car is really worth.
Let’s begin by being clear about what consumer surplus is: Consumer surplus is the amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it. When a person decides to buy a car, he must reconcile in his mind that the car is worth more to him than what he is paying for it. If he can’t do this, he won’t buy the car.
In general, when consumers engage in voluntary transactions, they generate consumer surplus. If they didn’t, they would simply choose not to buy the goods.
Consider this scenario: a woman is having a hard time deciding whether to buy a car with a price tag of $30,000. She values the car at $30,000, meaning her money is worth as much to her as the car. In economics, we say that she is indifferent between choice (a), buying the car, and choice (b), holding on to her money so she can spend it elsewhere. If she bought the car under these circumstances, she would obtain no consumer surplus from the transaction, and that is why she is reluctant to do so.
Now suppose that the car dealer notices her indecision, and he offers her a lower price, say, $25,000. The woman suddenly buys the car. Why? Because she values the car at $30,000, but she only has to pay $25,000 for it. She is obtaining $5,000 more in value than she is paying. As judged by her preferences, she is getting a bargain. The $5,000 difference represents her consumer surplus.
Consider the concept of consumer surplus the next time you go shopping. It won’t help you make wiser decisions. But for those of you who like shopping, you may enjoy it even more!