Consumer Surplus

1999 and 2006 by Peter Berck

Demand Curves
Demand: Amount that will be purchased as
a function of price p.
(Inverse) Demand: Price consumers will
pay for next unit as function of number of
units consumed, q.
P(Q) is willingness to pay for next unit

Willingness to Pay
Willingness to pay is area under demand.
demand price P(Q) is amount willing to pay for
next unit
So total willing to pay for Q units is P(1) +
P(2) + ...+ P(Q)
lower riemann sum and an approximation
the area under the demand curve between 0 and Q
units, which is the integral of demand, is (total)
willingness to pay

Calculating Total Willingness

70
60

Price

50
40

AREA
Demand

30
20
10
0
1

4
Quantity

Consumer Surplus
Consumer surplus is willingness to pay less
amount paid
Amount paid is P Q

Consumer surplus is willingness

to pay less amount paid
Willingness is blue + green. Surplus is
just the green
p

D
q

Willingness(Q)
The willingness to pay for q units is the
blue area while the willingness to pay
for q+n units is green and blue. Therefore
the willingness to pay for n extra units is
the green area
p

D
q

q+n

Money Measures-Theory
Think of projects as lowering prices.
A new bridge lowers the price of crossing the
bay by making one wait less time in toll plaza
lines
A new ski area lowers price by making the
commute from LA to skiing be shorter

Exact money measures

Equivalent Variation
Compensating Variation
For a normal good, consumer
surplus is in between these two
measures. (Willigs Theorem)

EV
The equivalent variation to a price
decrease from p0 to p1 is the amount of
money that makes the consumer just as well
off as if prices had decreased from p0 to p1

Equivalent Variation
140
120
Wine

100

Medium P

80
60

Low P
Higher y

40
20
0
0
Price of Wine = 1

20

40Bread60

80

100

CV
The compensating variation to a price
decrease from p0 to p1 (not pictured) is the
amount of money that, when subtracted
from the consumers income, leaves the
consumer just as well off at price p1 as he
would have been with his original income at
p0.

CV

Figure 5.5. Compensating Variation

10108
10050
10000
9950

9900
9850
9800

9750
9700

ii

9650
9600

II

9550
9500

III
4

MWH

10

Publicly Provided Good

35
30

ii

25
20

15
10
C
5
0

10

15

Wolves

20

25

30

35

EV and CV for Wolves

Starting from point A, we calculate CV for 5 more wolves
as follows. By adding 5 wolves, the consumer would be
on indifference curve ii at point B. To return to
indifference curve i, the consumer would need to give up
$10 in income, so the CV is $10. For EV, the question is,
how can we get the consumer back to indifference curve ii
without providing wolves? The consumer can get from
point A on i to point B on ii by adding 5 wolves, but even
an infinite amount of income will not get her to ii, holding
wolves constant; it will instead move her vertically along i.
Hence EV is infinite.

WTP for Public Good

40
35
30
Total Demand

25
20
15
Person 2's
Demand

Person 1's
Demand

10
5
0

10

Wolves

20

30

The marginal willingness to pay for a public good is the vertical sum of the individuals marginal willingness to pay values.

Value of Non Market Goods

Revealed Preference
Observe actions and deduce value
Travel Cost
Hedonic
Averting behavior

Stated Preference
Ask

Travel Cost
Fort Point beach was polluted
What was it worth?

Travel Cost: Method

(Krutilla and Fisher. Economics of Natural
Environments. Johns Hopkins University
Press. Baltimore. 1975. pp:189-218.
miles to measure price
income by county of origin
number of skiers by ski area
D(y, pThisArea, pOtherAreas, snow
conditions?)

Cost Benefit Analysis

A project is not bad if the benefits (to
whomever they may accrue) are greater
than the costs.
Take $20 from a homeless person and
(magically) give $21 to Bill Gates
Take $100 from Bill Gates and give $20 to a
homeless person.
(I am the .)

Should Mineral King be a Ski

Area
Would a new area make sense
Cost of new area (25 million dollars,
present value at 9%)
Cost of road (25 million dollars)
Willingness to pay for new area (8.2 to
26.7 million dollars present value)
Do we need to know what it is worth as
Wilderness?

Why did Disney want it?

Who paid and who benefited?
Beers, restaurants and lodging

long, steep, slippery road

monopoly profits to Disney
how does that change Disneys analysis
how does that change the public choice
problem