Alfred Marshall Consumer Surplus

Alfred Marshall Consumers Surplus, Marshall Surplus

Marshall's belief that the marginal utility of money was constant for small changes in prices permitted him (or so he thought) to draw certain conclusions in the area now known as welfare economics. In this case, too, Marshall's first ventures into new areas of economic theory have been followed by a large volume of literature interpreting and extending his analysis. The concept of consumers' surplus, first suggested by Marshall, is still being discussed in the literature of welfare economics.

Using Equation (11.2), MUa = Pa x MUm, and assuming that the marginal utility of money is constant, the price of good A and the marginal utility of good A are directly related. Marshall concluded that the price of good A is a measure of the marginal utility of good A to a consumer. Demand curves slope down and to the right because of diminishing marginal utility. Their downward slope indicates that consumers will be willing to pay more for earlier consumed units of a commodity than for later consumed units. In the market, however, consum­ers are able to buy all the units they consume at one price. Because this price measures the marginal utility of the last unit consumed, consumers obtain the earlier units, the intramarginal units, at a price less than they would be willing to pay. The difference between the total amount consumers would be willing to pay and what they actually pay constitutes consumers' surplus.

Marshall wished to use the concept of consumers' surplus to draw welfare conclusions; therefore, he was concerned with the surplus of consumers as a group rather than with the individual consumer's surplus. He worked with market-demand curves, not individual-demand curves. Given a market-demand curve as shown in Figure 10.1, we can analyze consumers' surplus. If the market price is OC, the quantity demanded will be OH. Because DD' is a market-demand curve, there are buyers who would have been willing to pay a higher price than OC. The OMth buyer would have been willing to pay a price of MP but paid only a price of MR. RP then represents that consumer's surplus. All the other intramarginal buyers also receive a consumers' surplus. The total consumers' surplus is equal to CDA, which is the difference between what consumers spent to buy the commodity, or OCAH, and what they would have been willing to spend, or ODAH.

CDA is, then, a measure of the monetary gain obtained by consumers in purchasing a commodity. To express this result a little differently, a monopolist practicing perfect price discrimination will work the consumers down their demand curve and in the process collect total revenues of ODAH; but in a competitive market in which all consumers buy at the single price of OC, the total expenditures of consumers are OCAH. CDA is therefore the amount the consumers save, or their monetary gain. Marshall, however, wanted to measure the gain in utility, and the monetary gain can be expressed as a gain in utility only if there is an invariable measure to transform price into utility. If the marginal utility of money remains constant as we move down the demand curve from price OD to MP to HA, then Marshall's consumers' surplus is an acceptable means of representing the gain in utility from consuming the good.

Consumers' Surplus

Marshall's use of prices to measure utility depends upon two assumptions: (1) that there is an additive utility function that ignores substitution and comple­mentary relationships; and (2) that the income effect from small price changes is negligible—that is, that the marginal utility of money is constant. Using a more generalized nonadditive utility function, Edgeworth suggested and Irving Fisher showed that although utility could be measured by using additive utility func­tions, this would not be possible if substitution and complementary effects were permitted. Furthermore, there was general criticism of the hedonistic element in the theory of demand presented by Marshall and others. Marshall responded to these criticisms by making some minor terminological changes, such as satisfac­tion for utility, but he basically held to the position that price could be used as a measure of utility. Marshall's awareness of the problems associated with meas­uring consumers' surplus led him to use the measure only for small changes in price in his applications to welfare economics. For small changes in price the assumption of constant marginal utility of money does not appear to be unrealistic, particularly if expenditures on the commodity in question represent only a small part of total consumer expendi­tures. The income effect of small price changes for most commodities is likely to be so small that it can be ignored.