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Economic surplus

Economic surplus

Overview

In mainstream economics
Mainstream economics
Mainstream economics is a loose term used to refer to widely-accepted economics as taught in prominent universities and in contrast to heterodox economics...

, economic surplus (also known as total welfare or Marshallian surplus after Alfred Marshall
Alfred Marshall
Alfred Marshall was an Englishman and one of the most influential economists of his time. His book, Principles of Economics , was the dominant economic textbook in England for many years...

) refers to two related quantities. Consumer surplus or consumers' surplus is the monetary gain obtained by consumers because they are able to purchase a product for a price that is less than the highest price that they would be willing to pay. Producer surplus or producers' surplus is the amount that producers benefit by selling at a market price that is higher than the least that they would be willing to sell for.

In some schools of heterodox economics
Heterodox economics
"Heterodox economics" refers to approaches or to schools of economic thought that are considered outside of "mainstream economics". Mainstream economists sometimes assert that it has little or no influence on the vast majority of academic economists in the English speaking world. "Mainstream...

, the economic surplus denotes the total income which the ruling class
Ruling class
The term ruling class refers to the social class of a given society that decides upon and sets that society's political policy - assuming there is one such particular class in the given society....

 derives from its ownership of scarce factors of production
Factors of production
In economics, factors of production means inputs and finished goods means output. Input determines the quantity of output i.e. output depends upon input. Input is the starting point and output is the end point of production process and such input-output relationship is called a production function...

, which is either reinvested or spent on consumption.

In Marxian economics
Marxian economics
Marxian economics refers to economic theories on the functioning of capitalism based on the works of Karl Marx. Adherents of Marxian economics, particularly in academia, distinguish it from Marxism as a political ideology and sociological theory, arguing that Marx's approach to understanding the...

, the term surplus may also refer to surplus value
Surplus value
Surplus value is a concept used famously by Karl Marx in his critique of political economy. Although Marx did not himself invent the term, he developed the concept...

, surplus product
Surplus product
Surplus product is a concept explicitly theorised by Karl Marx in his critique of political economy. Marx first began to work out his idea of surplus product in his 1844 notes on James Mill's Elements of political economy...

 and surplus labour
Surplus labour
Surplus labour is a concept used by Karl Marx in his critique of political economy. It means labour performed in excess of the labour necessary to produce the means of livelihood of the worker . According to Marxian economics, surplus labour is usually "unpaid labour"...

.

On a standard supply and demand
Supply and demand
Supply and demand is an economic model of price determination in a market. It concludes that in a competitive market, the unit price for a particular good will vary until it settles at a point where the quantity demanded by consumers will equal the quantity supplied by producers , resulting in an...

 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.
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Encyclopedia

In mainstream economics
Mainstream economics
Mainstream economics is a loose term used to refer to widely-accepted economics as taught in prominent universities and in contrast to heterodox economics...

, economic surplus (also known as total welfare or Marshallian surplus after Alfred Marshall
Alfred Marshall
Alfred Marshall was an Englishman and one of the most influential economists of his time. His book, Principles of Economics , was the dominant economic textbook in England for many years...

) refers to two related quantities. Consumer surplus or consumers' surplus is the monetary gain obtained by consumers because they are able to purchase a product for a price that is less than the highest price that they would be willing to pay. Producer surplus or producers' surplus is the amount that producers benefit by selling at a market price that is higher than the least that they would be willing to sell for.

In some schools of heterodox economics
Heterodox economics
"Heterodox economics" refers to approaches or to schools of economic thought that are considered outside of "mainstream economics". Mainstream economists sometimes assert that it has little or no influence on the vast majority of academic economists in the English speaking world. "Mainstream...

, the economic surplus denotes the total income which the ruling class
Ruling class
The term ruling class refers to the social class of a given society that decides upon and sets that society's political policy - assuming there is one such particular class in the given society....

 derives from its ownership of scarce factors of production
Factors of production
In economics, factors of production means inputs and finished goods means output. Input determines the quantity of output i.e. output depends upon input. Input is the starting point and output is the end point of production process and such input-output relationship is called a production function...

, which is either reinvested or spent on consumption.

In Marxian economics
Marxian economics
Marxian economics refers to economic theories on the functioning of capitalism based on the works of Karl Marx. Adherents of Marxian economics, particularly in academia, distinguish it from Marxism as a political ideology and sociological theory, arguing that Marx's approach to understanding the...

, the term surplus may also refer to surplus value
Surplus value
Surplus value is a concept used famously by Karl Marx in his critique of political economy. Although Marx did not himself invent the term, he developed the concept...

, surplus product
Surplus product
Surplus product is a concept explicitly theorised by Karl Marx in his critique of political economy. Marx first began to work out his idea of surplus product in his 1844 notes on James Mill's Elements of political economy...

 and surplus labour
Surplus labour
Surplus labour is a concept used by Karl Marx in his critique of political economy. It means labour performed in excess of the labour necessary to produce the means of livelihood of the worker . According to Marxian economics, surplus labour is usually "unpaid labour"...

.

Overview


On a standard supply and demand
Supply and demand
Supply and demand is an economic model of price determination in a market. It concludes that in a competitive market, the unit price for a particular good will vary until it settles at a point where the quantity demanded by consumers will equal the quantity supplied by producers , resulting in an...

 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.

Consumer surplus


Consumer surplus is the difference between the maximum price a consumer is willing to pay and the actual price they do pay. If a consumer would be willing to pay more than the current asking price, then they are getting more benefit from the purchased product than they spent to buy it. An example of a good with generally high consumer surplus is drinking water. People would pay very high prices for drinking water, as they need it to survive. The difference in the price that they would pay, if they had to, and the amount that they pay now is their consumer surplus. Note that the utility of the first few liters of drinking water is very high (as it prevents death), so the first few liters would likely have more consumer surplus than subsequent liters.

The maximum amount a consumer would be willing to pay for a given quantity of a good is the sum of the maximum price he would be willing to pay for the first unit, the (lower) maximum price he would be willing to pay for the second unit, etc. Typically these prices are decreasing; they are given by the individual demand curve
Demand curve
In economics, the demand curve is the graph depicting the relationship between the price of a certain commodity, and the amount of it that consumers are willing and able to purchase at that given price. It is a graphic representation of a demand schedule...

. For a given price the consumer buys the amount for which the consumer surplus is highest, where consumer surplus is the sum, over all units, of the excess of the maximum willingness to pay over the equilibrium (market) price. 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

The aggregate consumers' surplus is the sum of the consumer's surplus for all individual consumers. This can be represented graphically as shown in the above graph of the market demand and supply curves.

Calculation from supply and demand


The consumer surplus (individual or aggregated) is the area under the (individual or aggregated) demand curve and above a horizontal line at the actual price (in the aggregated case: the equilibrium price). If the demand curve is a straight line, the consumer surplus is the area of a triangle:


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
Integral
Integration is an important concept in mathematics and, together with its inverse, differentiation, is one of the two main operations in calculus...

 calculus. Consumer surplus is thus the definite integral of the demand function with respect to price, minus the definite integral of the constant function D(P)=Qmkt (i.e. PmktQmkt), from the market price to the maximum reservation price (i.e. the price-intercept of the demand function):


The graph shows, that if we see a rise in the equilibrium price and a fall in the equilibrium quantity, then consumer surplus falls.

Distribution of benefits when price falls


When supply of a good expands, the price falls (assuming the demand curve is downward sloping) and consumer surplus increases. This benefits two groups of people. Consumers who were already willing to buy at the initial price benefit from a price reduction; also they may buy more and receive even more consumer surplus, and additional consumers who were unwilling to buy at the initial price but will buy at the new price and also receive some consumer surplus.

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.

Rule of one-half


The rule of one-half estimates the change in consumer surplus for small changes in supply with a constant demand curve. Note that in this special case where the consumer demand curve is linear, consumer surplus is the area of a triangle. Following the figure above,


where:
  • CS = Consumers' Surplus
  • Q0 and Q1 are the quantity demanded before and after a change in supply
  • P0 and P1 are the prices before and after a change in supply

See also

  • Economic shortage
    Economic shortage
    Economic shortage is a term describing a disparity between the amount demanded for a product or service and the amount supplied in a market. Specifically, a shortage occurs when there is excess demand; therefore, it is the opposite of a surplus....

  • Deadweight loss
    Deadweight loss
    In economics, a deadweight loss is a loss of economic efficiency that can occur when equilibrium for a good or service is not Pareto optimal...

  • Induced demand
    Induced demand
    Induced demand, or latent demand, is the phenomenon that after supply increases, more of a good is consumed. This is entirely consistent with the economic theory of supply and demand; however, this idea has become important in the debate over the expansion of transportation systems, and is often...

  • Price discrimination
    Price discrimination
    Price discrimination or price differentiation exists when sales of identical goods or services are transacted at different prices from the same provider...

  • Price support
    Price support
    In economics, a price support may be either a subsidy or a price control, both with the intended effect of keeping the market price of a good higher than the competitive equilibrium level....

  • Shortage
  • Surplus economics
    Surplus economics
    Surplus economics is the study of economics based upon the concept that economies operate on the basis of the production of a surplus over basic needs.-Economic Surplus:...

  • Surplus product
    Surplus product
    Surplus product is a concept explicitly theorised by Karl Marx in his critique of political economy. Marx first began to work out his idea of surplus product in his 1844 notes on James Mill's Elements of political economy...

  • Surplus value
    Surplus value
    Surplus value is a concept used famously by Karl Marx in his critique of political economy. Although Marx did not himself invent the term, he developed the concept...

  • Utility
    Utility
    In economics, utility is a measure of customer satisfaction, referring to the total satisfaction received by a consumer from consuming a good or service....

  • Value added
    Value added
    In economics, the difference between the sale price and the production cost of a product is the value added per unit. Summing value added per unit over all units sold is total value added. Total value added is equivalent to Revenue less Outside Purchases...

  • Welfare economics
    Welfare economics
    Welfare economics is a branch of economics that uses microeconomic techniques to evaluate economic well-being, especially relative to competitive general equilibrium within an economy as to economic efficiency and the resulting income distribution associated with it...


Further reading

  • Henry George
    Henry George
    Henry George was an American writer, politician and political economist, who was the most influential proponent of the land value tax, also known as the "single tax" on land...

    , Progress and Poverty
    Progress and Poverty
    Progress and Poverty: An Inquiry into the Cause of Industrial Depressions and of Increase of Want with Increase of Wealth: The Remedy was written by Henry George in 1879...

    http://www.econlib.org/library/YPDBooks/George/grgPP.html