MARSHALLIAN CONSUMER SURPLUS THEORY

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Apple incorporation is one the earliest and greatest computer appliances company in the world. It is prided as having the latest and most versatile appliances used in the computer industry. The company is known for its unique designs and their customers are the greatest advertisers for their commodities. This is because; their products are high quality and unique, not to forget, always up to date. (Dimand, 2007)
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In economics, there are two theories that explain consumer surplus, which are the, Marshallian and the Hicksian consumer surplus. The two theories take different assumptions, and different people introduce them. Alfred Marshall introduces the Marshallian consumer theory while John Hicksian introduces Hicksian consumer surplus theory. According to the two economists the demand side of goods and services determine prices of the goods and services.

 

In economics, there is the principle of demand and supply. This principle of demand got discovered by Alfred Marshall who stated that, in a market, prices of products and services get determined by the demand side. He disagreed with the classical theories of economics which stated that the prices of goods and services got determined by the supply side. (Dimand, 2007)

 

The Marshallian consumer surplus and the producer’s surplus explain the total welfare in economics. The Marshallian consumer surplus received criticizing view from Hicksian consumer surplus. They all have different assumptions and have gained usage in economic and daily application. Industries and firms use both the Hicksian and Marshallian consumer surplus to analysis their markets. This paper refers Apple as a company that involves itself in production of technological devices such as the I pad. The company has a wide market globally for its products. Therefore, in this paper am using the both the Hicksian and Marshallian consumer surplus to explain whether it would be appropriate for Apple to approach its market using Marshallian consumer surplus. To be able to explain whether it is appropriate for the company to use Marshallian consumer surplus, I would review both the Marshallian and the Hicksian consumer surplus into details. (Dimand, 2007)

 

This paper contains five categories. The first category is the introduction which gives a brief background about consumer surplus. It highlights the thesis statement of this paper. The second section introduces the concept of consumer surplus by Alfred Marshall and discusses its underlying assumptions. The third section describes the Hicksian concept of Consumer surplus. In the fourth section, I explain whether or not the concept of Marshallian consumer surplus will give the Apple as company an accurate representation of total welfare in I pad marketing. The last section, which is the, firth section, is the conclusion. (Lind & Granqvist, 2010)

The Marshallian consumer surplus

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In the year 1890, principles of economics by Alfred Marshall got published. He introduced a theory of consumer and producer behavior. He introduced the derived demand and supply used them to derive the point of the equilibrium point, refers to the point where demand of services and goods and supply of the same are equal and balance each other. This brought the concept of consumer surplus. The idea then faced critics, considering it to be a striking novelty. (Dimand, 2007)

 

During his review, Marshall took a lot of attention in defining price and value, also referred to as utility in modern economics. He argued that prices paid for a commodity do not fully represent the value of a good. In addition, most people have the willingness to pay more than the actual price of a products or service and prefer not to go without a product or service. Utility gained by consuming a product or a service is not measurable by price. Is there a way to measure the satisfaction one gains after consuming a product or service? (Lind & Granqvist, 2010)

 

Marshall found out the excess price which was the wiliness to pay more than rather going without, was a, feasible, economic, measure the satisfaction gained. Additionally, it gets referred to as the consumer’s surplus. After defining the measure of the surplus satisfaction, he suggested a way to compute and represent the demand curve. (Dimand, 2007)

Figure 1.0

 

P*

 

 

Price

 

 

Quantity

 

 

Q*

 

 

 

 

 

In the diagram, above the P* denotes the equilibrium price while Q* denotes the equilibrium quantity. In the diagram, consumer surplus is the part under the demand curve and above the equilibrium price. The producer surplus is the area above the supply curve and below the equilibrium price. (McWilliams 2008)

 

Marshall considers marginal utility of consumption as constant. He justified this assumption since he considered the frame work of his concept was only partial equilibrium. He considered a market situation whereby an individual spends a certain percentage of his or her income and where change in price is small. He applies the Ceteris clause as a relevant tool and explores a market not affected by change in other goods and income. (Dimand, 2007)

 

According to Marshall if an individual spend minimum on goods considering the marginal utility of money to that individual become less. The individual would get an element of consumers’ surplus from purchasing other goods at a lower price. (Lind & Granqvist, 2010)

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According to Alfred a consumer surplus composes of three definitions. First is the consumer surplus as a surplus of satisfaction, also referred to as C.S.I. The second consumer surplus is an excess expenditure, also referred as the C.S.2 and the third consumer surplus in the area under the demand curve, but over the price line, commonly referred to as, C.S.3. Most goods are necessities; therefore, an individual will be willing to sacrifice anything so as to get them. C.S.2 ceases to be an appropriate measure of C.S.1 (Case, 1999)

 

Total welfare

 

To measure total welfare, the Marshallian welfare measures the changes in the consumer’s welfare. To explain the welfare, I use the above diagram. The Equilibriums point has an Equilibrium price (p*) and an Equilibrium quantity (Q*). (Dimand, 2007)

 

When the price of a product increases, the quantity demanded of that product decreases. Then the quantity demand for the products reduces from the initial equilibrium Q* to Q1. The decrease in the quantity demanded by the consumer affects the consumer surplus. The consumer surplus decreases while the producers’ surplus increases. Increase in a product price is disadvantages to the consumer. Whenever the supply of a commodity increases, the prices become lower hence profit margin decreases. As a result of this, fewer producers are willing to produce it due to the low returns. This causes a deficit in supply as demand exceeds the supply. This pushes the price of the commodity upwards hence the profit margin increases. The market adjusts itself automatically to maintain equilibrium where demand is equal to the supply, ceteris paribus. The scarcity of a commodity makes its market price go up, and businesses rely on this aspect to maximize on profit. (Case, 1999)

 

While the producers, of the product benefits. When the price increases it causes a welfare loss both to the producer and the consumer, called the dead weight. When the prices of the product decrease the Quantity for that product increase since the law of demand shows a negative relationship between price and demand. Therefore, the quantity demanded the product increases from the initial equilibrium Q* to Q2. The increase in the quantity demanded by the consumer affects both the consumer and producer surplus. The consumer surplus increases while the producer’s surplus reduces. The increase of the consumer’s surplus is a welfare gain. The consumer purchase the same products at a cheaper price, therefore, they increase their demand the product. When the price decreases it causes a welfare gain to the welfare. (Lind & Granqvist, 2010)

 

Limitation of Marshallian consumer surplus

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The Marshallian concept of consumer’s surplus gets criticized in the following areas: First some of the economists state that it is difficult to measure the consumer’s surplus by using Marshallian concept. According to Mark Blaug, he states that the demand curves are not asymptotic to the price axis. Secondly, in measuring consumer’s surplus real income does not remain constant along the demand curve. Thirdly the Marshallian concept depends on unrealistic marginal utility of money. Money utility does not remain constant, and it is impossible to measure utility of goods. Therefore, it is other economist state that the Marshallian consumer’ surplus is imaginary and hypothetical. The fourthly the concept states the consumer’s willingness to pay cannot exceed his income. This means that what he actual pay is equal to his or her income. Lastly the concept of Marshallian consumer’s surplus cannot be applied to essential and prestigious goods. (Lind & Granqvist, 2010)

Hicksian consumer surplus

 

After the introduction of Ordinalism in economic, the concept of consumer surplus got tied with measurability problems and lack a comparison component of utility. The situation changed when John R. Hicks employed indifference analysis to redefine consumer surplus. (Dimand, 2007)

 

The main reason why he returned to the concept of consumer surplus was to start so s to start a normative branch of economics. The branch was mainly to focus on welfare economics. He asserts that an economy does not necessary come to an optimum point in production and consumption. He came up with an idea in which an economy can be highly effective, but to achieve an effective economy there must be an economic policy that brings benefit and losses at the same time. (Case, 1999)

 

In Hicksian view, he does not use utility to measure the benefits and losses. He uses a size of compensation individuals would be willing to pay to cover their losses or benefits. Hicksian define consumers’ surplus as the measure of compensation which a customer would need so as to maintain himself in the current satisfaction, after the supply of the commodity gets withdrawn. (Lind & Granqvist, 2010)

 

Hicks’ four concepts of consumer surplus

 

Hicks developed ways to measure consumer’s surplus by assuming a change in price and compensating consumer. Therefore, leaving them as well off before there was a change in price. Hicksian also formulated four consumer’s surplus. They include, the quantity-compensation variation, the price compensating variation, the quantity equivalent variation and the price equivalent variation. (Case, 1999)

Uses of the of consumer surplus

 

First, the consumer surplus shows that the satisfaction derived in consuming a commodity is not represented by the price. The concept of consumer surplus gains usage in comparing the economic position of a consumer faced with two different price-quality situations. (Dimand, 2007)

 

The consumer surplus is referred to in comparison of the burden of both the direct and the indirect taxes. In most economies, the consumer surplus put into consideration in the formulation of fiscal policies. Taxation is high in those commodities with higher consumer surplus than to than those with a lower consumer surplus. (Lind & Granqvist, 2010)

 

The consumer surplus applies in the formulation of prices in a monopoly firm. It plays a significant role especially where price discrimination gets required. For example, it maintains the first degree of price discrimination by setting high prices for durable commodities with an intension that the high class consumers will buy the commodities. Then it lowers the price of the same class to attract those consumers with low capability to pay. (Case, 1999)

In international markets, the consumers’ surplus gains usage to estimate whether a country gains from trading with other nations or countries. It shows the exchange of goods between countries and evaluate whether a country should engage in foreign trade. The concept is also used to control and regulate imports and exports of goods and services in a country. (McWilliams 2008)

Empirical literature

Apple Company has decided to use Marshallian consumer surplus so as to represent their welfare. By doing this, it stops being a monopolistic company since it is the price maker. Therefore, its customer’s welfare is maximized because the company is now acting as a competitive firm that meets its customers. (Case, 1999)

To show the total welfare, I use an absolute graph to explain what happens in the market. In the graph, there are two curves, which are the, demand and the supply curve. The two curves help to determine the how the company will benefit by changing the prices of their products. The graph also shows the effects of change of the prices to Apple’s customers. The graph shows the change in quantity with respect the products prices. (McWilliams 2008)

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Figure 2.0

 

P1

 

 

 

Key:

P-price

Q-quantity

 

 

 

The Equilibriums point of the I pad market has an Equilibrium I pad product decreases. Then the quantity demand for I pad reduces from the initial equilibrium Q* to Q1. The decrease in the I pads demanded by I pad’s consumers affects the consumer surplus. The consumer surplus decreases while the producers’ surplus increases. Increase in I pads prices is disadvantages to the consumers while the I pad Company which is the producer in this case, benefits. When the price increases it causes a welfare loss both to the I pad company and its consumers. This welfare loss is called the dead weight. (Case, 1999)

 

When the price of I pads decreases, the Quantity of I pads demanded increases. This is because the law of demand states that when the price decreases the quantity demanded increases (ceteris paribus). Therefore, the quantity demanded the products increases from the initial equilibrium Q* to Q2. The increase in I pads demanded by the consumers affects both the consumer and producer surplus. The consumer surplus increases while the producer’s surplus reduces. The increase of the consumer’s surplus is a welfare gain. The consumers purchase the same I pads at cheaper prices. Therefore, they increase their demand I pads. When the prices decrease it causes a welfare gain. (Lind & Granqvist, 2010)

 

Conclusion

In conclusion, the consumer surplus concept is economics and it is mainly useful in determining the prices of goods and services. The consumer surplus is used in comparison of the burden of both the direct and the indirect taxes. In most economy, the consumer surplus is considered in the formulation of fiscal policies. Taxation is high in those commodities with higher consumer surplus than to than those with a lower consumer surplus. The consumer surplus is used in the formulation of prices in a monopoly firm. It plays a significant role especially where price discrimination is needed. For example, it maintains the first degree of price discrimination by setting high prices for durable commodities with an intension that the high class consumers will buy the commodities. Then it lowers the price of the same class to attract those consumers with a willingness to pay. (Lind & Granqvist, 2010)

 

References

Case, karl, & fair,Ray (1999). Principles of Economics (5th ed.). Prentice-Hall.

Lind, H. & R. Granqvist (2010) A Note on the Concept of Excess Burden. Economic Analysis and Policy 40:63-73.

McWilliams Tullberg, Rita (May 2008)., “Alfred Marshall(1842-1924)”, Oxford Dictionary of National Biography

Dimand, Robert W. (2007). “Keynes, IS-LM, and the Marshallian Tradition”. History of Political Economy (Duke University Press) 39 (1): 81–95.

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