Role Played by Consumers Surplus

The underlying motive for price discrimination can be understood using the concept of consumers' surplus. Consumers' surplus is the value of purchased goods and services above and beyond the amount paid to sellers. To illustrate, consider Figure 12.1, in which a market equilibrium price/output combination of P* and Q* is shown. The total value of output to customers is given by the area under the demand curve, or area 0ABQ*. Because the total revenue paid to producers is price times quantity, equal to area 0P*BQ*, the area P*AB represents the value of output above the amount paid to producers—that is, the consumers' surplus. For example, if a given customer is willing to pay $200 for a certain overcoat but is able to obtain a bargain price of $150, the buyer enjoys $50 worth of consumers' surplus. If another customer places a value of only $150 on the overcoat, he or she would enjoy no consumers' surplus following a purchase for $150.

Consumers' surplus arises because individual consumers place different values on goods and services. Customers that place a relatively high value on a product will pay high prices; customers that place a relatively low value on a product are only willing to pay low prices. As one proceeds from point A downward along the market marginal curve in Figure 12.1, customers that place a progressively lower marginal value on the product enter the market. At low prices, both high-value and low-value customers are buyers; at high prices, only customers that place a relatively high value on a given product are buyers.

When product value differs greatly among various groups of customers, a motive for price discrimination is created. By charging higher prices to customers with a high marginal value of consumption, revenues will increase without affecting costs. Sellers with the ability to vary prices according to the value placed on their products by buyers are able to capture at least

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