Ka-fu Wong University of Hong Kong

1
Ka-fu WongUniversity of Hong Kong
Economic Surplus in the supply and demand
framework
2
Economic surplus of producing the first unit
Price
D
S
10
MB
8
ES(1)10-2 8
6
4
MC
2
D
Quantity
0
1
2
3
4
5
3
Economic surplus of producing the second unit
Price
D
S
10
MB
8
ES(2)8-4 4
6
4
MC
2
D
Quantity
0
1
2
3
4
5
4
Economic surplus of producing the third unit
Price
D
S
10
8
ES(3)6-6 0
6
MB MC
4
2
D
Quantity
0
1
2
3
4
5
5
Economic surplus of producing the fourth unit
Price
D
S
10
MC
8
ES(4) 4-8 -4
6
4
MB
2
D
Quantity
0
1
2
3
4
5
6
Economic surplus of producing the fifth unit
Price
D
S
10
MC
8
ES(5) 2-10 -8
6
4
MB
2
D
Quantity
0
1
2
3
4
5
7
Total economic surplus
Unit Economic surplus from the n-th unit Total economic surplus 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.
8
Does the market equilibrium quantity also
maximize total economic surplus?

• The equilibrium quantity also maximizes total
  economic surplus
• if all costs of producing the good are borne
  directly by sellers, and
• if all benefits from the good accrue directly to
  buyers.

Price
S
D
Quantity
9
Does the market equilibrium quantity also
maximize total economic surplus?

• If output is less than market equilibrium
  quantity, the total economic surplus is less than
  that at market equilibrium quantity.
• There will be cash on the table.

Price
S
Thus, an increase in quantity produced will raise
total economic surplus!!
D
Quantity
Q0
10
Does the market equilibrium quantity also
maximize total economic surplus?

• If we produce more than the market equilibrium,
  our total surplus will equal
• red - blue

Price
S
D
Quantity
Q1
Thus, a reduction in quantity produced will raise
total economic surplus!!
11
Does the market equilibrium quantity also
maximize total economic surplus?

• If some costs of producing the good are not borne
  directly by sellers, the market equilibrium
  quantity will be Q0, determined by the supply and
  demand.
• However, the total economic surplus to the
  society is RED BLUE.

SMC PMC Pollution MC
S private marginal cost
Price
D
Quantity
Q0
Thus, a reduction in quantity produced will raise
total economic surplus!!
12
End