Willingness to Pay

Imagine that you own a mint-condition recording of Elvis Presley’s first album. Because you are not an Elvis Presley fan you decide to sell it. One way to do so is to hold an auction.

Four Elvis fans show up for your auction: john, George and Ringo. Each of them would like to own the album but there is a limit to the amount that each is willing to pay for it. Table the maximum pric that each of the four possible buyers would pay. Each buyer’s maximum is called his willingness to pay and it measures how much that buyer values the good. Each buyer would be eager to buy the album at a price less than his willingness to pay and he would refuse to buy the album at a price get rater than his willingness to pay. At a price equal to his willingness to pay the buyer would be indifferent about buying the good. If the price is exactly the same as the value he places on the album he would be equally happy buying it or keeping his money.

To sell your album you begin the bidding at a low price. Because all four buyers are willing to pay much more the price rises quickly. The bidding stops when John bids. At this point Paul, George and Ringo have dropped out of the bidding because they are unwilling to bid any more than. John pays you and gets the album. Note that the album has gone to the buyer who values the album most highly.

What benefit does John receive from buying the Elvis Presley album? In a sense John has found a real bargain. He is willing to pay $100 pay for the album but pays only for it. We say that John receives consumers surplus. Consumer surplus is the amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it.

Consumer surplus measures the benefit to buyers of participating in a market. In this example John receives a $20 benefit from participating in the auction because he pays only $80 for a good he values at $100. Paul, George and Ringo get no consumer surplus from participating in the auction because they left without the album and without paying anything.

Now consider a somewhat different example. Suppose that you had two identical Elvis Presley albums to sell. Again you auction them off to the four possible buyers. To keep things simple we assume that both albums are to be sold for the same price and that no buyer is interested in buying more than one album. Therefore the price rises until two buyers are left.

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