Q.(a) Explain the Theory of Consumer's Surplus with diagram.

(a) Consumer's surplus is the gap between what a buyer is willing to pay and what he actually pays; on a diagram it is the area between the demand curve and the price line. (b) Five cost concepts are money cost, real cost, opportunity cost, explicit cost and implicit cost.

PART (a): Theory of Consumer's Surplus (with diagram)

The concept of consumer's surplus was developed by Alfred Marshall.

Meaning: A consumer is often willing to pay more for a good than he actually has to pay. The difference between the price he is willing to pay and the price he actually pays is the consumer's surplus.

Consumer's Surplus = Price a consumer is willing to pay − Price actually paid

Explanation with a schedule (example): Suppose for successive units a consumer is willing to pay 10, 8, 6 and 4 (falling because of diminishing marginal utility), but the market price is 4 for each. He pays 4 × 4 = 16, though he was willing to pay 10 + 8 + 6 + 4 = 28. Consumer's surplus = 28 − 16 = 12.

Diagram (described in words): On a graph with price on the vertical axis and quantity on the horizontal axis, the demand curve DD slopes downward (showing falling willingness to pay). A horizontal price line PP is drawn at the market price. The area under the demand curve up to the quantity bought shows total willingness to pay; the rectangle below the price line shows the amount actually paid. The triangular area between the demand curve and the price line (above the price line and below the demand curve) represents the consumer's surplus.

Importance: it measures the extra satisfaction/benefit a consumer gets from a purchase, and is used to judge welfare and the effects of taxes and price changes.

PART (b): Any five Cost Concepts

1. Money cost — the total money expenditure incurred by a firm to produce a commodity (payments for raw materials, wages, rent, etc.). …