Consumer surplus is simply the difference between the maximum amount consumers would be willing to pay and the amount they actually pay for a good. The height of the demand curve measures how much buyers in the market value each unit of the good. The price indicates the amount they actually pay. The difference between these two-the triangular area below the demand curve but above the price paid-is a measure of the total consumer surplus generated by all exchanges of the good. The size of the consumer surplus, or triangular area, is affected by the market price. If the market price for the goods falls, more of it will be purchased, resulting in a larger surplus for consumers. Conversely, if the market price rises, less of it will be purchased, resulting in a smaller surplus (net gain) for consumers.
Because the value a consumer places on a particular unit of a good is shown by the corresponding height of the demand curve, we can use the demand curve to clarify the difference between the marginal value and total value of a good-a distinction we introduced briefly in previous posts. If consumers are currently purchasing Q, units, the marginal value of the good is indicated by the height of the demand curve at Q,-the last unit consumed (or purchased). So at each quantity, the height of the demand curve shows the marginal value of that unit, which as you can see, declines along a demand curve. The total value of the good, however, is equal to the combined value of all units purchased. This is the sum of the value of each unit (the heights along the demand curve) on the x-axis, out to, and including, unit Q,. This total value is indicated graphically as the entire area under the demand curve out to Q, (the triangular area representing consumer surplus plus the unshaded rectangular area directly below it).
You can see that the total value to consumers of a good can be far greater than the marginal value of the last unit consumed. When additional units are available at a low price, the marginal value of a good may be quite low, even though its total value to consumers is exceedingly high. This is usually the case with water, for example, because it is essential for life. The value of the first few units of water consumed per day will be exceedingly high. The consumer surplus derived from these units will also be large when water is plentiful at a low price. As more and more units are consumed, however, the marginal value of even something as important as water will fall to a low level. Thus, when water is cheap, people will use it not only for drinking, cleaning, and cooking, but also for washing cars, watering lawns, flushing toilets, and maintaining fish aquariums. Thus, although the total value of water is rather large, its marginal value is quite low.
Consumers will tend to expand their consumption of a good until its price and marginal value are equal.
Thus, the price of a good (which equals marginal value) reveals little about the total value derived from the consumption of it. This is the reason that the market price of diamonds (which reflects their high marginal value) is greater than the market price of water (which has a low marginal value), even though the total value of diamonds is far less than the total value of water. Think of it this way, beginning from your current levels of consumption, if you were offered a choice between one diamond or one gallon of water right now, which would you take? You would probably take the diamond, because at the margin it has more value to you than additional water. However, if given a choice between giving up all of the water you use or all of the diamonds you have, you would probably keep the water over diamonds, because in total water has more value to you.