How Changing Prices Affect Consumer Surplus

It is often important to know how much consumer surplus changes when the price changes. For example, we may want to know how much consumers are hurt if a flood in cotton-growing areas of Pakistan drives up cotton prices or how much consumers gain if the introduction of fish farming makes salmon steaks less expensive. The same approach we have used to derive consumer surplus can be used to answer questions about how changes in prices affect consumers.

Let’s return to the example of the market for used textbooks. Suppose that the bookstore decided to sell used textbooks for $20 instead of $30. How much would this fall in price increase consumer surplus?

The answer is illustrated in Figure 4-4. As shown in the figure, there are two parts to the increase in consumer surplus. The first part, shaded dark blue, is the gain of those who would have bought books even at the higher price of $30. Each of the students who would have bought books at $30—Aleisha, Brad, and Claudia—now pays $10 less, and therefore each gains $10 in consumer surplus from the fall in price to $20. So the dark blue area represents the $10 × 3 = $30 increase in consumer surplus to those three buyers.

Consumer Surplus and a Fall in the Price of Used Textbooks There are two parts to the increase in consumer surplus generated by a fall in price from $30 to $20. The first is given by the dark blue rectangle: each person who would have bought at the original price of $30—Aleisha, Brad, and Claudia—receives an increase in consumer surplus equal to the total reduction in price, $10. So the area of the dark blue rectangle corresponds to an amount equal to 3 × $10 = $30. The second part is given by the light blue area: the increase in consumer surplus for those who would not have bought at the original price of $30 but who buy at the new price of $20—namely, Darren. Darren’s willingness to pay is $25, so he now receives consumer surplus of $5. The total increase in consumer surplus is (3 × $10) + $5 = $35, represented by the sum of the shaded areas. Likewise, a rise in price from $20 to $30 would decrease consumer surplus by $35, the amount corresponding to the sum of the shaded areas.

The second part, shaded light blue, is the gain to those who would not have bought a book at $30 but are willing to pay more than $20. In this case that gain goes to Darren, who would not have bought a book at $30 but does buy one at $20. He gains $5—the difference between his willingness to pay of $25 and the new price of $20. So the light blue area represents a further $5 gain in consumer surplus.

The total increase in consumer surplus is the sum of the shaded areas, $35. Likewise, a rise in price from $20 to $30 would decrease consumer surplus by an amount equal to the sum of the shaded areas.

Figure 4-4 illustrates that when the price of a good falls, the area under the demand curve but above the price—which we have seen is equal to total consumer surplus—increases. Figure 4-5 shows the same result for the case of a smooth demand curve, the demand for iPads. Here we assume that the price of iPads falls from $2,000 to $500, leading to an increase in the quantity demanded from 200,000 to 1 million units.

As in the used-textbook example, we divide the gain in consumer surplus into two parts. The dark blue rectangle in Figure 4-5 corresponds to the dark blue area in Figure 4-4: it is the gain to the 200,000 people who would have bought iPads even at the higher price of $2,000. As a result of the price reduction, each receives additional surplus of $1,500. The light blue triangle in Figure 4-5 corresponds to the light blue area in Figure 4-4: it is the gain to people who would not have bought the good at the higher price but are willing to do so at a price of $500. For example, the light blue triangle includes the gain to someone who would have been willing to pay $1,000 for an iPad and therefore gains $500 in consumer surplus when it is possible to buy an iPad for only $500.

A Fall in the Price Increases Consumer Surplus A fall in the price of an iPad from $2,000 to $500 leads to an increase in the quantity demanded and an increase in consumer surplus. The change in total consumer surplus is given by the sum of the shaded areas: the total area below the demand curve and between the old and new prices. Here, the dark blue area represents the increase in consumer surplus for the 200,000 consumers who would have bought an iPad at the original price of $2,000; they each receive an increase in consumer surplus of $1,500. The light blue area represents the increase in consumer surplus for those willing to buy at a price equal to or greater than $500 but less than $2,000. Similarly, a rise in the price of an iPad from $500 to $2,000 generates a decrease in consumer surplus equal to the sum of the two shaded areas.

As before, the total gain in consumer surplus is the sum of the shaded areas: the increase in the area under the demand curve but above the price.

What would happen if the price of a good were to rise instead of fall? We would do the same analysis in reverse. Suppose, for example, that for some reason the price of iPads rises from $500 to $2,000. This would lead to a fall in consumer surplus, equal to the sum of the shaded areas in Figure 4-5. This loss consists of two parts. The dark blue rectangle represents the loss to consumers who would still buy an iPad, even at a price of $2,000. The light blue triangle represents the loss to consumers who decide not to buy an iPad at the higher price.

FOR INQUIRING MINDS: A Matter of Life and Death

In 2013, more than 6,500 Americans died because of a shortage of organs for transplant. As of 2014, more than 122,000 were wait-listed. And as you can see from the accompanying figure, the gap between the number of available organs and the number of organs actually donated continues to grow each year. (The difference you see between the number of living donors and the number of actual transplants is accounted for by organs transplanted from deceased patients.)

Since the number of those who need an organ far exceeds availability, what is the best way to allocate the available organs? A market isn’t feasible. And for understandable reasons, the sale of human body parts is illegal in this country. So the task for establishing a protocol for these situations has fallen to the nonprofit group United Network for Organ Sharing (UNOS).

Kidney transplants, the most common type of organ transplant, were the focus of attention when UNOS decided to reformulate its protocol for allocating organs to transplant recipients. Under previous guidelines, a donated kidney would go to the person who had been waiting the longest. According to this system, an available kidney would go to a 75-year-old who has been waiting for 2 years instead of to a 25-year-old who has been waiting for 6 months, even though the 25-year-old is likely to live longer and benefit from the transplanted organ for a longer period of time.

To address this issue, in 2013 UNOS adopted a new set of guidelines based on a concept it calls “net survival benefit.” Kidneys are ranked according to how long they are likely to last; similarly, recipients are ranked according to how long they are likely to live once receiving a transplanted kidney. Then, under the new guidelines, a kidney is matched to the recipient expected to achieve the greatest survival time from that kidney. In other words, a kidney expected to last many decades will be allocated to a relatively younger person, while older recipients will receive kidneys expected to last a fewer number of years.

Organ Donors, Transplants, and Waitlist, 1989-2013
Source: Based on OPTN data as of January 3, 2014.

By matching the expected life span of a kidney to the expected life span of the recipient following the transplant, the new UNOS guideline tries to avert situations in which (1) a recipient outlives the transplanted kidney, requiring yet another transplant and reducing the number of kidneys available to others; or (2) a kidney significantly outlives its recipient, thereby wasting years of kidney function that could have benefited someone else.

So what does all this have to do with consumer surplus? As you may have guessed, the UNOS concept of “net survival benefit” is a lot like individual consumer surplus—the individual consumer surplus generated from getting a new kidney. In essence, UNOS has devised a system that allocates a kidney according to who gets the greatest individual consumer surplus. This way, the UNOS guidelines attempt to maximize the total consumer surplus from the available pool of kidneys. In terms of results, then, the kidney allocation system under the new UNOS guidelines operates a lot like a competitive market.

!worldview! ECONOMICS in Action: When Money Isn’t Enough

When Money Isn’t Enough

The key insight we get from the concept of consumer surplus is that purchases yield a net benefit to the consumer because the consumer typically pays a price less than his or her willingness to pay for the good. Another way to say this is that the right to buy a good at the going price is a valuable thing in itself.

For those who purchased WWII ration coupons illegally, the right to consumer surplus had a steep price.
Ray Moreton/Keystone/Getty Images

Most of the time we don’t think about the value associated with the right to buy a good. In a market economy we take it for granted that we can buy whatever we want, as long as we are willing to pay the market price.

But that hasn’t always been true. For example, during World War II the demands of wartime production created shortages of consumer goods when these goods were sold at prewar prices. Rather than allow prices to rise, government officials in many countries created a system of rationing. To buy sugar, meat, coffee, gasoline, and many other goods, you not only had to pay cash; you also had to present stamps or coupons from books issued to each family by the government. These pieces of paper, which represented the right to buy goods at the government-regulated price, quickly became valuable commodities in themselves.

As a result, illegal markets in meat stamps and gasoline coupons sprang into existence. Moreover, criminals began stealing coupons and even counterfeiting stamps.

The funny thing was that even if you had bought a gasoline coupon on the illegal market, you still had to pay to purchase gasoline. So what you were buying on the illegal market was not the good but the right to buy the good at the government-regulated price. That is, people who bought ration coupons on the illegal market were paying for the right to get some consumer surplus.

Quick Review

  • The demand curve for a good is determined by each potential consumer’s willingness to pay.

  • Individual consumer surplus is the net gain an individual consumer gets from buying a good.

  • The total consumer surplus in a given market is equal to the area below the market demand curve but above the price.

  • A fall in the price of a good increases consumer surplus through two channels: a gain to consumers who would have bought at the original price and a gain to consumers who are persuaded to buy by the lower price. A rise in the price of a good reduces consumer surplus in a similar fashion.

4-1

  1. Question 4.1

    Consider the market for cheese-stuffed jalapeno peppers. There are two consumers, Casey and Josey, and their willingness to pay for each pepper is given in the accompanying table. (Neither is willing to consume more than 4 peppers at any price.) Use the table (i) to construct the demand schedule for peppers for prices of $0.00, $0.10, and so on, up to $0.90, and (ii) to calculate the total consumer surplus when the price of a pepper is $0.40.

    Quantity of peppers

    Casey’s willingness to pay

    Josey’s willingness to pay

    1st pepper

    $0.90

    $0.80

    2nd pepper

      0.70

      0.60

    3rd pepper

      0.50

      0.40

    4th pepper

      0.30

      0.30

Solutions appear at back of book.