Chapter 14 NAME

Consumer’s Surplus

Introduction. In this chapter you will study ways to measure a con-

sumer’s valuation of a good given the consumer’s demand curve for it.
The basic logic is as follows: The height of the demand curve measures
how much the consumer is willing to pay for the last unit of the good
purchased—the willingness to pay for the marginal unit. Therefore the
sum of the willingnesses-to-pay for each unit gives us the total willingness
to pay for the consumption of the good.
In geometric terms, the total willingness to pay to consume some
amount of the good is just the area under the demand curve up to that
amount. This area is called gross consumer’s surplus or total benefit
of the consumption of the good. If the consumer has to pay some amount
in order to purchase the good, then we must subtract this expenditure in
order to calculate the (net) consumer’s surplus.
When the utility function takes the quasilinear form, u(x) + m, the
area under the demand curve measures u(x), and the area under the
demand curve minus the expenditure on the other good measures u(x) +
m. Thus in this case, consumer’s surplus serves as an exact measure of
utility, and the change in consumer’s surplus is a monetary measure of a
change in utility.
If the utility function has a different form, consumer’s surplus will not
be an exact measure of utility, but it will often be a good approximation.
However, if we want more exact measures, we can use the ideas of the
compensating variation and the equivalent variation.
Recall that the compensating variation is the amount of extra income
that the consumer would need at the new prices to be as well off as she
was facing the old prices; the equivalent variation is the amount of money
that it would be necessary to take away from the consumer at the old
prices to make her as well off as she would be, facing the new prices.
Although different in general, the change in consumer’s surplus and the
compensating and equivalent variations will be the same if preferences are
quasilinear.
In this chapter you will practice:

• Calculating consumer’s surplus and the change in consumer’s surplus

• Calculating compensating and equivalent variations

Example: Suppose that the inverse demand curve is given by P (q) =

100 − 10q and that the consumer currently has 5 units of the good. How
much money would you have to pay him to compensate him for reducing
his consumption of the good to zero?
Answer: The inverse demand curve has a height of 100 when q = 0
and a height of 50 when q = 5. The area under the demand curve is a
trapezoid with a base of 5 and heights of 100 and 50. We can calculate
182 CONSUMER’S SURPLUS (Ch. 14)

the area of this trapezoid by applying the formula

1
Area of a trapezoid = base × (height1 + height2 ).
2

In this case we have A = 5 × 12 (100 + 50) = $375.

Example: Suppose now that the consumer is purchasing the 5 units at a
price of $50 per unit. If you require him to reduce his purchases to zero,
how much money would be necessary to compensate him?
In this case, we saw above that his gross benefits decline by $375.
On the other hand, he has to spend 5 × 50 = $250 less. The decline in
net surplus is therefore $125.
Example: Suppose that a consumer has a utility function u(x1 , x2 ) =
x1 + x2 . Initially the consumer faces prices (1, 2) and has income 10.
If the prices change to (4, 2), calculate the compensating and equivalent
variations.
Answer: Since the two goods are perfect substitutes, the consumer
will initially consume the bundle (10, 0) and get a utility of 10. After the
prices change, she will consume the bundle (0, 5) and get a utility of 5.
After the price change she would need $20 to get a utility of 10; therefore
the compensating variation is 20 − 10 = 10. Before the price change, she
would need an income of 5 to get a utility of 5. Therefore the equivalent
variation is 10 − 5 = 5.

14.1 (0) Sir Plus consumes mead, and his demand function for tankards
of mead is given by D(p) = 100 − p, where p is the price of mead in
shillings.

(a) If the price of mead is 50 shillings per tankard, how many tankards of

mead will he consume? 50.

(b) How much gross consumer’s surplus does he get from this consump-

tion? 3,750.

(c) How much money does he spend on mead? 2,500.

(d) What is his net consumer’s surplus from mead consumption?

1,250.
14.2 (0) Here is the table of reservation prices for apartments taken
from Chapter 1:
Person = A B C D E F G H
Price = 40 25 30 35 10 18 15 5
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(a) If the equilibrium rent for an apartment turns out to be $20, which

consumers will get apartments? A,B,C,D.

(b) If the equilibrium rent for an apartment turns out to be $20, what

is the consumer’s (net) surplus generated in this market for person A?

20. For person B? 5.

(c) If the equilibrium rent is $20, what is the total net consumers’ surplus

generated in the market? 50.

(d) If the equilibrium rent is $20, what is the total gross consumers’

surplus in the market? 130.

(e) If the rent declines to $19, how much does the gross surplus increase?

0.
(f ) If the rent declines to $19, how much does the net surplus increase?

4.
Calculus 14.3 (0) Quasimodo consumes earplugs and other things. His utility
function for earplugs x and money to spend on other goods y is given by

x2
u(x, y) = 100x − + y.
2

(a) What kind of utility function does Quasimodo have? Quasilinear.

(b) What is his inverse demand curve for earplugs? p = 100 − x.

(c) If the price of earplugs is $50, how many earplugs will he consume?

50.

(d) If the price of earplugs is $80, how many earplugs will he consume?

20.
(e) Suppose that Quasimodo has $4,000 in total to spend a month. What
is his total utility for earplugs and money to spend on other things if the

price of earplugs is $50? $5,250.

184 CONSUMER’S SURPLUS (Ch. 14)

(f ) What is his total utility for earplugs and other things if the price of

earplugs is $80? $4,200.

(g) Utility decreases by 1,050 when the price changes from $50 to
$80.

(h) What is the change in (net) consumer’s surplus when the price changes

from $50 to $80? 1,050.

14.4 (2) In the graph below, you see a representation of Sarah Gamp’s
indifference curves between cucumbers and other goods. Suppose that
the reference price of cucumbers and the reference price of “other goods”
are both 1.
Other goods

40
0
A

30
0

20
0

B
10

0 10 20 30 40
Cucumbers

(a) What is the minimum amount of money that Sarah would need in

order to purchase a bundle that is indifferent to A? 20.

(b) What is the minimum amount of money that Sarah would need in

order to purchase a bundle that is indifferent to B? 30.

(c) Suppose that the reference price for cucumbers is 2 and the reference
price for other goods is 1. How much money does she need in order to

purchase a bundle that is indifferent to bundle A? 30.

(d) What is the minimum amount of money that Sarah would need to

purchase a bundle that is indifferent to B using these new prices? 40.

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(e) No matter what prices Sarah faces, the amount of money she needs
to purchase a bundle indifferent to A must be (higher, lower) than the

amount she needs to purchase a bundle indifferent to B. lower.

14.5 (2) Bernice’s preferences can be represented by u(x, y) = min{x, y},
where x is pairs of earrings and y is dollars to spend on other things. She
faces prices (px , py ) = (2, 1) and her income is 12.

(a) Draw in pencil on the graph below some of Bernice’s indifference

curves and her budget constraint. Her optimal bundle is 4 pairs

of earrings and 4 dollars to spend on other things.

Dollars for other things

16

Black line
12

Pencil lines
8 Blue lines

4
Red
line

0 4 8 12 16
Pairs of earrings

(b) The price of a pair of earrings rises to $3 and Bernice’s income stays
the same. Using blue ink, draw her new budget constraint on the graph

above. Her new optimal bundle is 3 pairs of earrings and

3 dollars to spend on other things.

(c) What bundle would Bernice choose if she faced the original prices and

had just enough income to reach the new indifference curve? (3, 3).
Draw with red ink the budget line that passes through this bundle at
the original prices. How much income would Bernice need at the original

prices to have this (red) budget line? $9.

 186 CONSUMER’S SURPLUS (Ch. 14)

(d) The maximum amount that Bernice would pay to avoid the price

increase is $3. This is the (compensating, equivalent) variation in

income. Equivalent.
(e) What bundle would Bernice choose if she faced the new prices and had

just enough income to reach her original indifference curve? (4, 4).
Draw with black ink the budget line that passes through this bundle at
the new prices. How much income would Bernice have with this budget?

$16.
(f ) In order to be as well-off as she was with her original bundle, Bernice’s

original income would have to rise by $4. This is the (compensating,

equivalent) variation in income. Compensating.

Calculus 14.6 (0) Ulrich likes video games and sausages. In fact, his preferences
can be represented by u(x, y) = ln(x + 1) + y where x is the number of
video games he plays and y is the number of dollars that he spends on
sausages. Let px be the price of a video game and m be his income.

(a) Write an expression that says that Ulrich’s marginal rate of substi-
tution equals the price ratio. ( Hint: Remember Donald Fribble from

Chapter 6?) 1/(x + 1) = px .

(b) Since Ulrich has quasilinear preferences, you can solve this
equation alone to get his demand function for video games, which is

x = 1/px − 1. His demand function for the dollars to spend on

sausages is y = m − 1 + p.
(c) Video games cost $.25 and Ulrich’s income is $10. Then Ulrich de-

mands 3 video games and 9.25 dollars’ worth of sausages.

His utility from this bundle is 10.64. (Round off to two decimal

places.)

(d) If we took away all of Ulrich’s video games, how much money would

he need to have to spend on sausages to be just as well-off as before?

$10.64.
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(e) Now an amusement tax of $.25 is put on video games and is passed

on in full to consumers. With the tax in place, Ulrich demands 1

video game and 9.5 dollars’ worth of sausages. His utility from this

bundle is 10.19. (Round off to two decimal places.)

(f ) Now if we took away all of Ulrich’s video games, how much money
would he have to have to spend on sausages to be just as well-off as with

the bundle he purchased after the tax was in place? $10.19.

(g) What is the change in Ulrich’s consumer surplus due to the tax?

−.45 How much money did the government collect from Ulrich by

means of the tax? $.25.

Calculus 14.7 (1) Lolita, an intelligent and charming Holstein cow, consumes
only two goods, cow feed (made of ground corn and oats) and hay. Her
preferences are represented by the utility function U (x, y) = x − x2 /2 + y,
where x is her consumption of cow feed and y is her consumption of hay.
Lolita has been instructed in the mysteries of budgets and optimization
and always maximizes her utility subject to her budget constraint. Lolita
has an income of $m that she is allowed to spend as she wishes on cow
feed and hay. The price of hay is always $1, and the price of cow feed will
be denoted by p, where 0 < p ≤ 1.

(a) Write Lolita’s inverse demand function for cow feed. (Hint: Lolita’s
utility function is quasilinear. When y is the numeraire and the price of
x is p, the inverse demand function for someone with quasilinear utility

f (x) + y is found by simply setting p = f ′ (x).) p = 1 − x.

(b) If the price of cow feed is p and her income is m, how much hay does
Lolita choose? (Hint: The money that she doesn’t spend on feed is used

to buy hay.) m − p(1 − p).

(c) Plug these numbers into her utility function to find out the utility level

that she enjoys at this price and this income. u = m+(1−p)2 /2.
(d) Suppose that Lolita’s daily income is $3 and that the price of feed is

$.50. What bundle does she buy? (1/2, 11/4). What bundle would

she buy if the price of cow feed rose to $1? (0, 3).
188 CONSUMER’S SURPLUS (Ch. 14)

(e) How much money would Lolita be willing to pay to avoid having the

price of cow feed rise to $1? 1/8. This amount is known as the

equivalent variation.

(f ) Suppose that the price of cow feed rose to $1. How much extra money
would you have to pay Lolita to make her as well-off as she was at the

old prices? 1/8. This amount is known as the compensating

variation. Which is bigger, the compensating or the equivalent variation,

or are they the same? Same.

(g) At the price $.50 and income $3, how much (net) consumer’s surplus

is Lolita getting? 1/8.

14.8 (2) F. Flintstone has quasilinear preferences and his inverse demand
function for Brontosaurus Burgers is P (b) = 30 − 2b. Mr. Flintstone is
currently consuming 10 burgers at a price of 10 dollars.

(a) How much money would he be willing to pay to have this amount

rather than no burgers at all? $200. What is his level of (net)

consumer’s surplus? $100.

(b) The town of Bedrock, the only supplier of Brontosaurus Burgers,
decides to raise the price from $10 a burger to $14 a burger. What

is Mr. Flintstone’s change in consumer’s surplus? At price

$10, consumer’s surplus is $100. At $14,
he demands 8 burgers, for net consumer’s
1
surplus of 2 (16 × 8) = 64. The change in
consumer’s surplus is −$36.
14.9 (1) Karl Kapitalist is willing to produce p/2 − 20 chairs at every
price, p > 40. At prices below 40, he will produce nothing. If the price

of chairs is $100, Karl will produce 30 chairs. At this price, how

1
much is his producer’s surplus? 2 (60 × 30) = 900.
14.10 (2) Ms. Q. Moto loves to ring the church bells for up to 10
hours a day. Where m is expenditure on other goods, and x is hours of
bell ringing, her utility is u(m, x) = m + 3x for x ≤ 10. If x > 10, she
develops painful blisters and is worse off than if she didn’t ring the bells.
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Her income is equal to $100 and the sexton allows her to ring the bell for
10 hours.

(a) Due to complaints from the villagers, the sexton has decided to restrict
Ms. Moto to 5 hours of bell ringing per day. This is bad news for Ms.

Moto. In fact she regards it as just as bad as losing $15 dollars of

income.

(b) The sexton relents and offers to let her ring the bells as much as she
likes so long as she pays $2 per hour for the privilege. How much ringing

does she do now? 10 hours. This tax on her activities is as bad

as a loss of how much income? $20.

(c) The villagers continue to complain. The sexton raises the price of

bell ringing to $4 an hour. How much ringing does she do now? 0

hours. This tax, as compared to the situation in which she could

ring the bells for free, is as bad as a loss of how much income? $30.