Demonstrate how the principle of willingness to pay underlies consumer surplus and the practice of price discrimination. Explain the equilibrium solution to an industry that is able to practice perfect price discrimination.
The conception of the consumer's surplus originated from the Marshallian theory of cardinal utility.
KD is the marginal utility curve. The price is given by OP. So E is the equilibrium point that obeys the two conditions (both necessary and sufficient).
Let us consider that the consumer is consuming 0B amount. For 0Bth unit the consumer is willing to pay BL units of money but he actually needs to pay BG units. His willingness to pay is greater than his actual payment. So he will raise the consumption and consequently there will be a decline in the willingness to pay by the consumer. Finally at point E the willingness to pay matches with the actual payments.
The marginal utility curve is the demand curve as it depicts the demand price of the commodity at each corresponding level of consumption. On the other hand at each level of price the equilibrium demand for the commodity by the consumer is determined by the marginal utility curve.
In the above diagram the total willingness to pay is measured by summing up the willingness to pay at each level of q. Hence the total willingness to pay is given by the area of 0KEA and actual payment is P.q.
The difference between total utility (willingness to pay in terms of money) and the total expenditure on the goods consumed. Graphically the portion below the demand curve and above the price line represents consumer's surplus. (Sen, 2002)
The first degree of price discr ...