In mainstream economics, economic surplus, also known as total welfare or total social welfare or Marshallian surplus (after Alfred Marshall), is either of two related quantities:
On a standard supply and demand diagram, consumer surplus is the area (triangular if the supply and demand curves are linear) above the equilibrium price of the good and below the demand curve. This reflects the fact that consumers would have been willing to buy a single unit of the good at a price higher than the equilibrium price, a second unit at a price below that but still above the equilibrium price, etc., yet they in fact pay just the equilibrium price for each unit they buy.
Likewise, in the supply-demand diagram, producer surplus is the area below the equilibrium price but above the supply curve. This reflects the fact that producers would have been willing to supply the first unit at a price lower than the equilibrium price, the second unit at a price above that but still below the equilibrium price, etc., yet they in fact receive the equilibrium price for all the units they sell.
William Petty
David Hume approached the agricultural surplus concept from another direction. Hume recognized that agriculture may feed more than those who cultivate it, but questioned why farmers would work to produce more than they need. Forceful production, which may occur under a feudal system, would be unlikely to generate a notable surplus in his opinion. Yet, if they could purchase luxuries and other goods beyond their necessities, they would become incentivized to produce and sell a surplus. Hume did not see this concept as abstract theory, he stated it as a fact when discussing how England developed after the introduction of foreign luxuries in his History of England.
Adam Smith's thoughts on surplus drew on Hume. Smith noted that the desire for luxuries is infinite compared to the finite capacity of hunger. Smith saw the development in Europe as originating from landlords placing more importance on luxury spending rather than political power.
The maximum amount a consumer would be willing to pay for a given quantity of a good is the sum of the maximum price they would pay for the first unit, the (lower) maximum price they would be willing to pay for the second unit, etc. Typically these prices are decreasing; they are given by the individual demand curve, which must be generated by a rational consumer who maximizes utility subject to a budget constraint. Because the demand curve is downward sloping, there is diminishing marginal utility. Diminishing marginal utility means a person receives less additional utility from an additional unit. However, the price of a product is constant for every unit at the equilibrium price. The extra money someone would be willing to pay for the number units of a product less than the equilibrium quantity and at a higher price than the equilibrium price for each of these quantities is the benefit they receive from purchasing these quantities. For a given price the consumer buys the amount for which the consumer surplus is highest. The consumer's surplus is highest at the largest number of units for which, even for the last unit, the maximum willingness to pay is not below the market price.
Consumer surplus can be used as a measurement of social welfare, shown by Robert Willig. For a single price change, consumer surplus can provide an approximation of changes in welfare. With multiple price and/or income changes, however, consumer surplus cannot be used to approximate economic welfare because it is not single-valued anymore. More modern methods are developed later to estimate the welfare effect of price changes using consumer surplus.
The aggregate consumers' surplus is the sum of the consumer's surplus for all individual consumers. This aggregation can be represented graphically, as shown in the above graph of the market demand and supply curves. The aggregate consumers' surplus can also be said to be the maxim of satisfaction a consumer derives from particular goods and services.
where Pmkt is the equilibrium price (where supply equals demand), Qmkt is the total quantity purchased at the equilibrium price, and Pmax is the price at which the quantity purchased would fall to 0 (that is, where the demand curve intercepts the price axis). For more general demand and supply functions, these areas are not triangles but can still be found using integral calculus. Consumer surplus is thus the definite integral of the demand function with respect to price, from the market price to the maximum reservation price (i.e., the price-intercept of the demand function):
where This shows that if we see a rise in the equilibrium price and a fall in the equilibrium quantity, then consumer surplus falls.
Consider an example of linear supply and demand curves. For an initial supply curve S0, consumer surplus is the triangle above the line formed by price P0 to the demand line (bounded on the left by the price axis and on the top by the demand line). If supply expands from S0 to S1, the consumers' surplus expands to the triangle above P1 and below the demand line (still bounded by the price axis). The change in consumer's surplus is difference in area between the two triangles, and that is the consumer welfare associated with expansion of supply.
Some people were willing to pay the higher price P0. When the price is reduced, their benefit is the area in the rectangle formed on the top by P0, on the bottom by P1, on the left by the price axis and on the right by line extending vertically upwards from Q0.
The second set of beneficiaries are consumers who buy more, and new consumers, those who will pay the new lower price ( P1) but not the higher price ( P0). Their additional consumption makes up the difference between Q1 and Q0. Their consumer surplus is the triangle bounded on the left by the line extending vertically upwards from Q0, on the right and top by the demand line, and on the bottom by the line extending horizontally to the right from P1.
where:
Obviously, the manufacturer produces and sells a certain quantity of Q1 goods at the market price P1. The manufacturer has reduced the quantity of goods for Q1, which means that the manufacturer has increased the production factors or production costs equivalent to the amount of AVC· Q1. However, at the same time, the manufacturer actually obtains a total income equivalent to the total market price P1· Q1. Since AVC is always smaller than P1, from the production and sales of goods in Q1, manufacturers not only get sales revenue equivalent to variable costs, but also get additional revenue. This part of the excess income reflects the increase in the benefits obtained by the manufacturers through market exchange. Therefore, in economics, producer surplus is usually used to measure producer welfare and is an important part of social welfare.
Producer surplus is usually used to measure the economic welfare obtained by the manufacturer in the market supply. When the supply price is constant, the producer welfare depends on the market price. If the manufacturer can sell the product at the highest price, the welfare is the greatest. As part of social welfare, the size of the producer surplus depends on many factors. Generally speaking, when other factors remain constant, an increase in market price will increase producer surplus, and a decrease in supply price or marginal cost will also increase producer surplus. If there is a surplus of goods, that is, people can only sell part of the goods at market prices, and producer surplus will decrease.
Obviously, the sum of the producer surplus of all manufacturers in the market constitutes the producer surplus of the entire market. Graphically, it should be expressed as the area enclosed by the market supply curve, the market price line and the coordinate axis.
/ref> used a broad definition of necessities, leading him to focus on employment issues surrounding surplus. Petty explains a hypothetical example in which there is a territory of 1000 men and 100 of those men are capable of producing enough food for all 1000 men. The question becomes, what will the rest of the men do if only 100 are needed to provide necessities? He thereby suggests a variety of employments with some remaining unemployed.
Consumer surplus
Calculation from supply and demand
Calculation of a change in consumer surplus
Distribution of benefits when price falls
Rule of one-half
Producer surplus
Calculation of producer surplus
See also
Further reading
|
|