The social surplus

Econ 1, Fred E. Foldvary

  Mankiw Chapter 7, Consumers and Producers


Consumption means the using up of economic value.

When you buy something you do not use up immediately, that value retained is an economic investment until it is consumed.

But to simplify the language, we assume that "consumers" soon consume what they buy.

"Welfare" in economics does not mean government subsidies to the poor or others, but the economic well-being of society, usually as measured by per-capita GDP.
"Welfare economics" is the analysis of how government policy affects social welfare.
The social welfare is the social surplus

Have you ever bought something at a lower price than the most you would have paid?
This is called a consumer surplus.
Graphically, the area between the demand curve and the market price is the surplus.

The points along a demand curve reflect the marginal willingness or pay and the marginal benefits of the good.

The consumer surplus is the welfare or benefit obtained by buyers from goods.
P. 138: John, Paul, George and Ringo!


Production is the creation of economic value.

The supply curve represents the marginal costs of production, where

the cost includes all opportunity costs, all that must be foregone to produce the good.

Supply curves for good in current production slope up.

Therefore, the lower-cost producers receive a revenue greater than their cost of labor and capital goods.

This is a producer surplus, although the producer does not necessarily receive it.

Graphically, the area between the supply curve and the market price is the surplus.

Who gets the producer surplus?

Economic profit is revenue minus all explicit costs and minus all opportunity costs.

In a competitive market, the economic profits are driven down to zero.

So producers do not get the surplus.

If there is a monopoly such as with a patent, the producer can get the surplus.

In a competitive labor market, workers do not get the surplus either, because wages equalize to the

marginal product of labor.

So the surplus goes to the rent of landowners.

Indeed, this is the origin of rent, the better areas having a higher surplus after paying for labor and

capital goods.

The producer-surplus triangle is the same phenomenon as the rent triangle in the classical model

of rent and wages!

Where labor has a monopoly, it also gets a surplus.

Examples would include movie, TV, music, and sports stars who get millions of dollars for a

performance. But these are rare cases. Most of the producer surplus is land rent.

The social surplus is the sum of the producer and consumer surplus.

It is really the sum of rent plus consumer surplus.

There is also a separate workers' surplus

Market efficiency

Efficiency means the ratio of output to input.

Economic efficiency refers to the efficiency of the social surplus obtained from the allocation of resources.

If an allocation is inefficient, it implies that there are gains from trade which have been blocked by government intervention.

Another criterion for judging economic outcomes is equity or fairness.

Another one is moral considerations: one may think that certain outcomes are immoral;

for example, if you think gambling is immoral and favor banning it.

The social surplus is maximized when there are no market-hampering interventions,

therefore where prices are set by market equilibria without price controls or taxes on production.

That policy is called laissez-faire.

Market Failure.

A pure market has voluntary action.

"Market failure" is the systematic inability of entrepreneurs to provide wanted goods, or

an outcome of a lower social surplus than what is economically possible.

"Market power" is the ability of a firm to set its price.

A monopoly with market power can set a high price and reduce the quantity relative to that set in a competitive market.

However, there can be compensating benefits, such as better products.

Also, the nature of a product may make the monopoly the best we can do.

And, government remedies can be worse. In that case, the market does not fail.

Externality or external effect: uncompensated costs or benefits on others.

Externalities are caused by a lack of property rights, and are thus a government failure to establish and protect such rights, rather than a failure of the pure market.

Question: In a competitive market with no monopolies, who gets the producer surplus? Why?