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

2 Economic surplus of producing the first unit D DS Price Quantity MB MC ES(1)=10-2 = 8

3 Economic surplus of producing the second unit D DS Price Quantity MB MC ES(2)=8-4 = 4

4 Economic surplus of producing the third unit D DS Price Quantity MB = MC ES(3)=6-6 = 0

5 Economic surplus of producing the fourth unit D DS Price Quantity MC MB ES(4) = 4-8 = -4

6 Economic surplus of producing the fifth unit D DS Price Quantity MC MB ES(5) = 2-10 = -8

7 Total economic surplus Unit Economic surplus from the n-th unit Total economic surplus from the first n units 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. D S Price 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. D S Price Quantity Q0Q0 Thus, an increase in quantity produced will raise total economic surplus!!

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 D S Price Quantity Q1Q1 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. D S= private marginal cost Price Quantity SMC = PMC + Pollution MC Q0Q0 Thus, a reduction in quantity produced will raise total economic surplus!!

12 End