Question

As the price of a service rises, (LO6) a) the consumer surplus decreases b) the consumer surplus increases c) the consumer surplus may increase or decrease

Short answer

As the price of a service rises, the consumer surplus decreases (option a). This is because the difference between consumers' willingness to pay and the actual price they pay will decrease, resulting in a lower economic benefit for the consumers.

Step-by-step solution

Understand the concept of consumer surplus

Consumer surplus is the difference between the willingness to pay (the highest price a consumer is willing to pay for a product or service) and the actual price paid by the consumer. It indicates the economic benefit that consumers receive when the price of a product or service is lower than what they are willing to pay.

Analyze the relationship between price and consumer surplus

When the price of a service increases, consumers are required to pay more for the same service. This means that the difference between their willingness to pay and the actual price they pay will decrease. As a result, their consumer surplus will decrease.

Choose the correct option

Based on the above analysis of the relationship between price and consumer surplus, we can conclude: a) As the price of a service rises, the consumer surplus decreases.

Key concepts

Willingness to Pay

Understanding the concept of 'willingness to pay' is essential to grasp the fundamentals of consumer surplus. Willingness to pay is essentially the maximum amount that a consumer is ready to spend on a good or service, reflecting the value they place on it. This personal valuation varies among individuals, as it is based on their preferences, incomes, and the perceived benefit they'll receive from the product.

For instance, if someone values a concert ticket highly and is willing to pay up to \(100 for it, their willingness to pay is \)100. However, if they manage to purchase the ticket for \(70, the consumer surplus they experience is the difference between these two amounts, which in this case is \)30. This surplus can be seen as a measure of the consumer's gained satisfaction or utility from the transaction. To cement this concept, one can imagine the joy of finding a desired item on sale; the savings experienced mirror the consumer surplus.

Economic Benefit

The economic benefit in the context of consumer surplus corresponds to the advantage gained when consumers pay less than what they are willing to pay for a good or service. This benefit is not simply theoretical; it has practical implications. When consumers experience surplus, they may use their savings for other goods or services, effectively increasing their purchasing power and overall utility.

The economic benefit is thus a cornerstone of consumer choice and market efficiency. It can lead to increased consumer satisfaction and retention, as consumers perceive they are getting more value for their money. Economic benefit also has macroeconomic implications, as the accumulated surplus of consumers can translate into higher spending within the economy, propelling growth and furthering the circulation of money.

Price and Consumer Surplus Relationship

The relationship between price and consumer surplus is inversely proportional; as one rises, the other tends to fall. The price of a service or good is pivotal in this dynamic, acting as the lever that adjusts the level of the consumer surplus. When a price ascends, the gap between what consumers are willing to pay and the price they actually pay narrows, reducing consumer surplus.

To visualize this, imagine a ladder where each rung is a potential price point. As consumers climb up, each step costs more, leaving less of a gap between the price they are climbing from and the one they are willing to reach. If prices escalate too much, the surplus might disappear altogether, leaving consumers less satisfied and potentially driving them away from the market. Conversely, when prices decrease, consumer surplus escalates, providing consumers with a heightened sense of getting a bargain, which can stimulate additional purchases and enhance welfare.