Consumer surplus

What is it?

‘Consumer surplus’ is an economic term, referring to the difference between what someone would have been ready and willing to pay for a particular item and what they actually ended up paying for it.

The irrelevance of consumer surplus to contract damages

As we will see, it has been suggested by some academics and judges that in a breach of contract case, the damages payable to the victim of the breach may in some way reflect or protect the victim’s consumer surplus. This is untrue.

Suppose that you contract to sell me a ticket to a Bruce Springsteen concert for £100. I would have been ready and willing to pay £300 for a ticket (I’m relatively well off, and love The Boss), so my consumer surplus on this transaction is £200. You then tell me that you won’t be able to get me a ticket for the concert after all – your supplier of Springsteen tickets has let you down.

If I can get a ticket from another source for, say, £150, then you will be liable to pay me £50 in damages: the difference between what I would have paid you had you properly performed, and what I’ve ended up having to pay someone else for what I entitled to from you.

If I can’t get a ticket from another source to the concert, then – as this was a contract for fun – I’ll be entitled to sue you for damages for the loss of enjoyment of attending the concert. Awarding such damages requires the court to put a monetary value on how much I would have enjoyed attending the concert. Some might argue that this should be assessed according to how much I would have been ready and willing to pay for a ticket (£300) – but this is a mistake. How much I would have been ready and willing to pay for a ticket not only reflects my assessment of how much I would enjoy going to a Bruce Springsteen concert, but also how much money I have got in my pocket. So I might value the enjoyment of attending a Bruce Springsteen concert at £1,000, but only have been ready and willing to pay £300 for a ticket because I simply don’t have enough money to be able to afford to splash out £1,000 on a Bruce Springsteen concert. One way of putting a monetary value on how much I would have enjoyed attending the concert is to ask – Once I had the ticket, how much would I have been willing to sell it for? It makes sense that I would not have sold the ticket for less than the monetary value that I put on the enjoyment of attending the concert. It’s highly unlikely that once I got the ticket to go to the Bruce Springsteen concert that I would have been willing to sell it just for £300. It’s likely that I would only have been ready and willing to sell the ticket for a lot more money than I would have been ready and willing to buy the ticket for. Let’s say that had I got the ticket, I would have been ready and willing to sell it to someone else for £750. In that case, we should value my loss of enjoyment from not attending the concert at £750 and award me £650 in damages – £750 minus the £100 I have saved as a result of your breach because I no longer have to pay you for the ticket.

So – if you breach your contract with me to supply me with a ticket to the Bruce Springsteen concert, I will either be able to sue you for £50 (if I can get a ticket from another source) or £650 (if I can’t). In neither case can I sue you for £200 – which is my consumer surplus on my transaction with you. My consumer surplus is completely irrelevant to how much I might be able to sue you for.

Consumer surplus in the cases

Despite this, there are a number of cases which say that damages awards in breach of contract cases can be designed to protect the victim of breach’s ‘consumer surplus’.

In Ruxley Electronics and Construction Ltd v Forsyth (1996), Lord Mustill said that ‘the law must cater for those occasions where the value of the promise to the promisee exceeds the financial enhancement of his position which full performance will secure. This excess, often referred to in the literature as the “consumer surplus”…is usually incapable of precise valuation in terms of money, exactly because it represents a personal, subjective and non-monetary gain. Nevertheless where it exists the law should recognise it and compensate the promisee if the misperformance takes it away.’

In Farley v Skinner (2002), Lord Steyn observed of Lord Mustill’s judgment in Ruxley that ‘for Lord Mustill…the principle of pacta sunt servanda [contracts must be kept] would be eroded if the law did not take account of the fact that the consumer often demands specifications which, although not of economic value, have value to him. This is sometimes called the “consumer surplus”… Lord Mustill rejected the idea that “the promisor can please himself whether or not to comply with the wishes of the promise[e] which, as embodied in the contract, formed partof the consideration for the price”.’

Lord Steyn did go on to say that ‘Labels sometimes obscure rather than illuminate. I do not therefore set much store by the description “consumer surplus”.’ Quite right too. It is obvious that in these passages the phrase ‘consumer surplus’ is being misused to act as synonym for ‘enjoyment’ or ‘pleasure’. So when we say (1) ‘The law can award damages to compensate the victim of a breach of contract for the loss of his consumer surplus’ all we are actually saying is (2) ‘The law can award damages to compensate the victim of a breach of contract for the loss of the pleasure or enjoyment he would have obtained from proper performance of the contract’. But if that’s the case, then why not say (2) rather than (1)? We should prefer simple words whose meaning is plainly obvious over complex words whose meaning has to be explained. And we should definitely not borrow concepts from another discipline where they have a particular, technical meaning and then use those concepts to say something completely different. Doing so can only make it even more difficult for other people to understand what we are saying.

The source of the problem

The blame for the fact that the language of ‘consumer surplus’ has now crept into judgments on assessing damages for breach of contract in cases where the victim of the breach has suffered a loss of enjoyment (and from there has gotten into the textbooks – where even more confusingly, they sometimes distinguish between a claim in contract for distress and loss of enjoyment, and a claim for loss of one’s ‘consumer surplus’) must be laid squarely at the foot of an article published in the Law Quarterly Review in 1979: Harris, Ogus and Phillips, ‘Contract remedies and the consumer surplus’ (1979) 95 Law Quarterly Review 581. The article is not available online, so I will quote in full from the crucial passage in the article where the authors introduce the concept of ‘consumer surplus’ (while discussing the decision of Oliver J in Radford v De Froberville (1977)). The passage is at pp 582-83 of the article:

‘The existence of the wall on the new boundary of his land [in Radford v De Froberville] was worth more to the plaintiff than the increase which the wall would make to the market value of the land; it was argued that he valued the particular architectural style and privacy it afforded more highly than the average purchaser of the land. This is an example of what economists refer to as “consumer surplus”, the excess utility or subjective value obtained from a “good” over and above the utility associated with its market price. (As explained below, the consumer surplus expected by a person who intends to use a good is equivalent to the profit which a businessman expects to make from the contract.) The concept of consumer surplus is important in any attempt to measure consumer losses because, unlike firms, consumers make purchases for the pleasure or utility they confer; this utility has no necessary relationship with the price paid and is of a quite different order from market prices or business profits. It is, of course, difficult to measure utility, but generally economists avoid the conceptual problem by measuring utility in terms of the maximum amount a consumer would pay for a particular purchase. For instance, if a purchaser can buy a plot of land for £1,000, when he would be prepared to pay up to £1,500 for it, the extra £500 represents his “consumer surplus”.’

Notice how the authors end up correctly defining how a purchaser’s ‘consumer surplus’ on the purchase of land is assessed. But for the whole of the rest of the passage, ‘consumer surplus’ is simply identified with the difference between how much pleasure or enjoyment (or, in the authors’ language, ‘utility’) one will obtain from a good, and how much you have paid for that good. That is not how economists define the term ‘consumer surplus’, but unfortunately that does seem to be the definition that has crept into the cases (and from there the textbooks), via the Harris, Ogus and Phillips article.

It is time to stop the rot. Lawyers should stop talking about ‘consumer surplus’ and stick to their knitting. When they are actually talking about damages being awarded for loss of enjoyment or pleasure then they should actually talk in terms of damages being awarded for loss of enjoyment or pleasure. And students should do the same in writing essays and problem answers and avoid at all costs using the phrase ‘consumer surplus’ (unless positively required to do so by the terms of the essay or problem question).