Economic Surplus in the supply and demand framework

Economic Surplus in the supply and demand framework Ka-fu Wong University of Hong Kong 1

Economic surplus of producing the first unit Price MB 10 D S 8 ES(1)=10 -2 = 8 6 4 MC 2 D 0 1 Quantity 2 3 4 5 2

Economic surplus of producing the second unit Price 10 MB D S 8 ES(2)=8 -4 = 4 6 MC 4 2 D 0 1 Quantity 2 3 4 5 3

Economic surplus of producing the third unit Price 10 D S 8 ES(3)=6 -6 = 0 6 MB = MC 4 2 D 0 1 Quantity 2 3 4 5 4

Economic surplus of producing the fourth unit Price 10 MC D S 8 ES(4) = 4 -8 = -4 6 MB 4 2 D 0 1 Quantity 2 3 4 5 5

Economic surplus of producing the fifth unit Price MC 10 D S 8 ES(5) = 2 -10 = -8 6 4 MB 2 D 0 1 Quantity 2 3 4 5 6

Total economic surplus Unit Economic surplus from Total economic surplus the n-th unit from the first n units 1 8 8 2 4 12 3 0 12 4 -4 8 5 -8 0 Total economic surplus is maximized at 2 and 3 units. 7

Does the market equilibrium quantity also maximize total economic surplus? n The equilibrium quantity also maximizes total economic surplus n if all costs of producing the good are borne directly by sellers, and n if all benefits from the good accrue directly to buyers. Price S D Quantity 8

Does the market equilibrium quantity also maximize total economic surplus? n If output is less than market equilibrium quantity, the total economic surplus is less than that at market equilibrium quantity. n There will be cash on the table. Price S Thus, an increase in quantity produced will raise total economic surplus!! D Q 0 Quantity 9

Does the market equilibrium quantity also maximize total economic surplus? n If we produce more than the market equilibrium, our total surplus will equal n red - blue Price S D Q 1 Quantity Thus, a reduction in quantity produced will raise total economic surplus!! 10

Does the market equilibrium quantity also maximize total economic surplus? n If some costs of producing the good are not borne directly by Price sellers, the market equilibrium quantity will be Q 0, determined by the supply and demand. n However, the total economic surplus to the society is RED – BLUE. SMC = PMC + Pollution MC S= private marginal cost D Quantity Q 0 Thus, a reduction in quantity produced will raise total economic surplus!! 11

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