All else equal, what happens to consumer surplus if the price of a good increases?
a. Consumer surplus increases.
b. Consumer surplus decreases.
c. Consumer surplus is unchanged.
d. Consumer surplus may increase, decrease, or remain unchanged.
The correct answer and explanation is :
The correct answer is:
b. Consumer surplus decreases.
Explanation:
Consumer surplus is a measure of the economic benefit that consumers receive when they are able to purchase a good at a price lower than the maximum price they are willing to pay. It is represented by the area below the demand curve and above the price level on a graph.
To understand how an increase in the price of a good affects consumer surplus, let’s break it down:
- Price and Consumer Surplus:
- When the price of a good increases, consumers who are willing to pay more than the new price but less than the original price will no longer purchase the good. This results in a loss of consumer surplus because these consumers are priced out of the market.
- Additionally, for the consumers who do continue to purchase the good, they now have to pay a higher price. This reduces the difference between the price they are willing to pay and the price they actually pay, thus reducing their individual surplus.
- The Area of Consumer Surplus:
- On a graph, the consumer surplus is the area between the demand curve and the price line, up to the quantity purchased. When the price rises, the price line moves up, shrinking the area of consumer surplus.
- The higher price also reduces the quantity demanded, leading to a smaller number of transactions at the new, higher price. This reduces the total consumer surplus even further, as fewer consumers are able to purchase the good.
- Market Effects:
- If the price increase leads to a decrease in quantity demanded, fewer consumers are able to take advantage of the lower prices they would have enjoyed at the original price. The area representing consumer surplus shrinks, and thus, overall consumer welfare decreases.
Thus, all else being equal, an increase in price will decrease consumer surplus because consumers are paying more for the same good or are no longer able to afford it at all.