Economic surplus 101: definition, types, causes
- Surplus refers to an excess of production or supply over demand.
- Economic surplus is made up of two parts, consumer surplus and producer surplus, and is a measure of market welfare.
- Certain factors, such as overproduction or underproduction and taxes, can affect economic surplus and market efficiency.
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The term “surplus” generally refers to having more of something than is actually needed or used. But what the surplus actually means can vary considerably in different contexts. For example, a budget surplus occurs when the government collects more tax revenue than it spends. Since he has money left, there is a budget surplus.
But a surplus is not always a good thing. When it comes to business, excess inventory can mean having excess inventory in stock due to lack of demand. There is also the economic surplus, which refers to the sum total of two parts – consumer surplus and producer surplus – and reflects the surplus that each part enjoys in a particular economic activity. Although there are different types of surplus with different definitions, we will mainly focus on the economic surplus.
Understanding how the economic surplus works
Economic surplus refers to the respective gains that a consumer or producer obtains from an economic activity and is the combined benefit, sometimes referred to as “total welfare”. It can also be called total surplus or community surplus.
This economic measure is used to assess well-being in markets. When a consumer gets an item for less than he would be willing to pay, the consumer gets a surplus. When a producer sells a good at a price higher than the minimum price at which he is willing to sell it, the producer obtains a surplus.
The economic surplus follows the rules of supply and demand. Businesses generally want to make as much profit as possible without alienating customers, while consumers generally want to feel like they’re making a deal.
When the supply and demand of consumers and producers are in good shape, the market is in what is called “equilibrium” – or allocative efficiency.
“In a competitive market, the market is in equilibrium when the price of a good or service is such that the total quantity of that good or service that buyers are willing and able to buy is exactly equal to the quantity total that sellers are willing and able to sell, ”explains Dr Zoé Plakias, assistant professor in the Department of Agricultural, Environmental, and Development Economics at Ohio State University. “At equilibrium price and quantity in a perfectly competitive market, the total surplus, which is the sum of consumer surplus and producer surplus, is maximized. When surplus is maximized in a market, we say that the market is efficient. “
The equilibrium price refers to the price to which the objectives of consumers and producers correspond. In other words, it is the price at which consumers are willing to buy and producers are willing to sell. The equilibrium quantity means the exact quantity of a particular good where supply and demand meet.
What are the different types of economic surplus?
The economic surplus has two parts: the consumer surplus and the producer surplus. These two types of surplus differ but both represent a particular gain for the consumer or the producer.
A consumer surplus refers to the monetary benefit a consumer receives when they purchase a good for less than the maximum amount they would be willing to pay in this scenario. Consumer surplus refers to the marginal profit – or the highest price they would pay – less what they actually paid.
Producer surplus refers to the monetary gain that producers get by selling a particular good above the lowest price at which they would be willing to sell. Marginal cost refers to the additional costs that a producer incurs when producing more than one particular good.
When there is a “balance” between consumer surplus and producer surplus, the marginal benefit as well as the marginal cost are of the same value.
What causes an economic surplus?
As mentioned earlier, the concept of economic surplus is closely related to supply and demand. In other words, what is the available quantity of a particular good and what is the demand for it?
The law of supply and demand is intrinsically linked to consumers and producers, the two parties that constitute the economic surplus. The law of supply suggests that as the price of a particular good increases, so does its quantity or supply. The reverse is also true in that when the price goes down, the supply goes down as well.
The law of demand suggests that when the price of a particular item increases, the demand decreases. In other words, as the cost of a product increases, there are fewer consumers in the market willing to pay for it. The reverse is also true, so that if the price goes down, demand goes up.
The main cause of an economic surplus is when the supply and demand for a particular good are not synchronized. This upsets the market balance, which can lead to variations in the price of a particular good or in the quantity produced.
Some factors that can affect economic surplus and market efficiency include:
- Overproduction, or have too much of a particular item produced.
- Under production, or have too little of a particular item created.
- Taxes, as this can lead to higher prices for consumers and lower production for suppliers.
- High transaction costs, which can be prohibitive for both consumers and producers.
“These surpluses are caused by a mismatch between supply and demand. If there are too many TVs in stock, sellers will likely have to cut prices or even sell them at a loss to reduce inventory,” Tsang explains. “But if those same TVs are in low supply and demand stays the same or even increases, then they may sell them for more than what we would generally be willing to pay.”
The financial report
Surplus can refer to many things, but economic surplus is used to assess market conditions and the benefits to consumers and producers. But it’s a small part of something much bigger.
“This idea of surplus captures only the costs and benefits of production and consumption that fall on buyers and sellers,” Plakias notes. “For example, if there are costs or benefits borne by others external to the market, or if the market is not perfectly competitive, then without any intervention, the price and the quantity that we observe in the market are generally not effective and we probably want to address that as a society.
In this case, the government can play a role in the market conditions. When assessing the economic surplus. It is important to note that this is not all.
Plakias notes that “the total surplus tells us nothing about the fairness and distribution of benefits among people in the economy, which we care about as a society and which we probably want to factor into our decisions.”