What’s it: Consumer surplus refers to the difference between the highest price consumers are willing to pay and the actual price they pay for a good or service.
For example, you are willing to pay Rp6 to buy a product. In the market, you come across a producer who sells products for Rp4. The difference of Rp2 (Rp6-Rp4) is your surplus.
In the diagram, the total consumer surplus is shown by the area under the demand curve, and the actual price paid by consumers (equilibrium price). The total surplus is the sum of all individual surpluses. We calculate the total surplus by the following formula
Consumer surplus = (1/2) x Qe x (Pmax – Pe)
Implications of consumer surplus
The highest consumer surplus occurs when the producer’s economic profit is zero. Conversely, the value is zero when producers can implement perfect price discrimination or first-degree price discrimination. Perfect price discrimination occurs when producers set prices according to the highest price an individual is willing to pay.
Why the free market? Because in that market, the actual price reflects the equilibrium price. Assuming that there is no shift in demand when producers set prices above equilibrium prices, the surplus decreases. That situation could happen, for example, in a monopoly market, where producers have absolute power over prices, quantities, and quality of products in the market.