I think there is a tale to tell about the consumer surplus and it goes like this.
Alice loves widgets. She would pay $100 for a widget. She goes on line and finds Bob offering widgets for sale for $100. Err, that is not really what she had in mind. She imagined paying $30 for a widget, and feeling $70 better off as a consequence. She emails Bob: How about $90?
Bob feels like giving up altogether. It takes him ten hours to hand craft a widget and the minimum wage where he lives is $10 an hour. He was offering widgets for $150. $100 is the absolute minimum. Bob replies: No.
While Alice is deciding whether to pay $100 for a widget that is only worth $100 to her, Carol puts the finishing touches to her widget making machine. At the press of a button Carol can produce a widget for only $10. She activates her website, offering widgets for $40. Alice orders one at once.
How would Eve the economist like to analyse this? She would like to identify a consumer surplus of 100 − 40 = 60 dollars, and a producer surplus of 40 − 10 = 30 dollars, for a total gain from trade of 60 + 30 = 90 dollars. But before she can do this she has to telephone Alice and Carol and find out the secret numbers, $100 and $10. Only the market price of $40 is overt.
Alice thinks Eve is spying for Carol. If Carol learns that Alice is willing to pay $100, she will up the price to $80. So Alice bullshits Eve: Yeh, I’m regretting my purchase, I’ve rushed to buy a widget, but what’s it worth really? $35. I’ve over paid.
Carol thinks Eve is spying for Alice. If Alice learns that they only cost $10 to make, then she will bargain Carol down to $20. Carol bullshits Eve: Currently they cost me $45 to make, but if I can grow volumes I’ll get a bulk discount on raw materials and I hope to be making them for $35 and be in profit by 2016.
Eve realises that she isn’t going to be able to get the numbers she needs, so she values the trade at its market price and declares GDP to be $40. It is what economist do. It is the desperate expedient to which the opacity of business has reduced them.
Now for the twist in the tale. Carol presses the button on her widget making machine, which catches fire and is destroyed. Carol gives up widget making. Alice buys from Bob for $100. Neither is happy with the deal; the total of consumer surplus and producer surplus is zero. Alice is thinking that she would have been happier spending her $100 eating out. Bob is thinking that he would have had a nicer time earning his $100 waiting tables for 10 hours.
Eve revises her GDP estimate. She has committed herself to market prices, so it is up 150% at $100. Err, that is not what is supposed to happen. Vital machinery is lost in a fire, prices soar and goods are produced by tedious manual labour, the economy has gone to shit, producing no surplus instead of producing a $90 surplus. But Eve’s figures make this look good.
I agree that there is a problem with the consumer surplus. It is too hard to discover. But the market price is actually irrelevant. Going with the number you can get, even though it doesn’t relate to what you want to know is another kind of fake, in some ways worse.
Disclaimer: I’m not an economist. Corrections welcomed.
Bob is thinking that he would have had a nicer time earning his $100 waiting tables for 10 hours.
If that job’s available, why doesn’t he do it instead? If it’s not, what’s the point of focusing on his wishing—he might as well wish he were a millionaire.
The missing detail in your story is what Bob did to earn money while Carol’s machine was working. If he was doing something better than hand-making widgets, he wouldn’t go back to widgetry unless he could sell at a higher price. And if he was doing something less good than making widgets, he’s happy that Carol’s machine burned down.
Another point is that if Carol’s machine can make widgets more cheaply than Bob, then it might make more them, satisfying more market demand. This should cause GDP to rise since it multiplies items sold by price. How common is the case of very inelastic demand (if that’s the right term)?
These points probably shouldn’t change your conclusion that GDP is often a bad measure.
Disclaimer: I’m even less of an economist than you are.
You’ll need to fix the start of your post: (emphasis mine):
Alice loves widgets. She would pay $100 for a widget. She goes on line and finds Bob offering widgets for sale for $100. Err, that is not really what she had in mind.
That’s exactly what she had in mind since she would pay $100. I think it’s better to change it to “Alice would pay $95 for a widget”.
A couple of other points. Eve’s life is very slightly easier since prices of widgets change which means she can estimate part of the demand curve and then estimate the consumer surplus from there. Also, GDP and what it measures has nothing to do with the consumer surplus.
Perhaps she’d be willing to pay $100 for a widget if there were no other option, but would nonetheless prefer to pay less if that can be arranged.
Transaction and information costs are a huge problem. People spend a lot of time paying them in actual life — for instance, driving to work or to the store; standing in lines; searching for bargains; clipping coupons; and so on.
Alice is willing to incur an email round-trip time to distinguish a world where $100 widgets are the only offer from a world in which a $90 widget is also available. She considers that the delay of one round-trip of haggling is worth $10 times the probability of a lower offer existing.
(Other factors obtain, too, like minimizing regret — if she bought a widget for $100 and then immediately saw Bob sell one to Faye for $90, she’d feel like $10 worth of fool.)
I think there is a tale to tell about the consumer surplus and it goes like this.
Alice loves widgets. She would pay $100 for a widget. She goes on line and finds Bob offering widgets for sale for $100. Err, that is not really what she had in mind. She imagined paying $30 for a widget, and feeling $70 better off as a consequence. She emails Bob: How about $90?
Bob feels like giving up altogether. It takes him ten hours to hand craft a widget and the minimum wage where he lives is $10 an hour. He was offering widgets for $150. $100 is the absolute minimum. Bob replies: No.
While Alice is deciding whether to pay $100 for a widget that is only worth $100 to her, Carol puts the finishing touches to her widget making machine. At the press of a button Carol can produce a widget for only $10. She activates her website, offering widgets for $40. Alice orders one at once.
How would Eve the economist like to analyse this? She would like to identify a consumer surplus of 100 − 40 = 60 dollars, and a producer surplus of 40 − 10 = 30 dollars, for a total gain from trade of 60 + 30 = 90 dollars. But before she can do this she has to telephone Alice and Carol and find out the secret numbers, $100 and $10. Only the market price of $40 is overt.
Alice thinks Eve is spying for Carol. If Carol learns that Alice is willing to pay $100, she will up the price to $80. So Alice bullshits Eve: Yeh, I’m regretting my purchase, I’ve rushed to buy a widget, but what’s it worth really? $35. I’ve over paid.
Carol thinks Eve is spying for Alice. If Alice learns that they only cost $10 to make, then she will bargain Carol down to $20. Carol bullshits Eve: Currently they cost me $45 to make, but if I can grow volumes I’ll get a bulk discount on raw materials and I hope to be making them for $35 and be in profit by 2016.
Eve realises that she isn’t going to be able to get the numbers she needs, so she values the trade at its market price and declares GDP to be $40. It is what economist do. It is the desperate expedient to which the opacity of business has reduced them.
Now for the twist in the tale. Carol presses the button on her widget making machine, which catches fire and is destroyed. Carol gives up widget making. Alice buys from Bob for $100. Neither is happy with the deal; the total of consumer surplus and producer surplus is zero. Alice is thinking that she would have been happier spending her $100 eating out. Bob is thinking that he would have had a nicer time earning his $100 waiting tables for 10 hours.
Eve revises her GDP estimate. She has committed herself to market prices, so it is up 150% at $100. Err, that is not what is supposed to happen. Vital machinery is lost in a fire, prices soar and goods are produced by tedious manual labour, the economy has gone to shit, producing no surplus instead of producing a $90 surplus. But Eve’s figures make this look good.
I agree that there is a problem with the consumer surplus. It is too hard to discover. But the market price is actually irrelevant. Going with the number you can get, even though it doesn’t relate to what you want to know is another kind of fake, in some ways worse.
Disclaimer: I’m not an economist. Corrections welcomed.
If that job’s available, why doesn’t he do it instead? If it’s not, what’s the point of focusing on his wishing—he might as well wish he were a millionaire.
The missing detail in your story is what Bob did to earn money while Carol’s machine was working. If he was doing something better than hand-making widgets, he wouldn’t go back to widgetry unless he could sell at a higher price. And if he was doing something less good than making widgets, he’s happy that Carol’s machine burned down.
Another point is that if Carol’s machine can make widgets more cheaply than Bob, then it might make more them, satisfying more market demand. This should cause GDP to rise since it multiplies items sold by price. How common is the case of very inelastic demand (if that’s the right term)?
These points probably shouldn’t change your conclusion that GDP is often a bad measure.
Disclaimer: I’m even less of an economist than you are.
You’ll need to fix the start of your post: (emphasis mine):
That’s exactly what she had in mind since she would pay $100. I think it’s better to change it to “Alice would pay $95 for a widget”.
A couple of other points. Eve’s life is very slightly easier since prices of widgets change which means she can estimate part of the demand curve and then estimate the consumer surplus from there. Also, GDP and what it measures has nothing to do with the consumer surplus.
Perhaps she’d be willing to pay $100 for a widget if there were no other option, but would nonetheless prefer to pay less if that can be arranged.
Transaction and information costs are a huge problem. People spend a lot of time paying them in actual life — for instance, driving to work or to the store; standing in lines; searching for bargains; clipping coupons; and so on.
Alice is willing to incur an email round-trip time to distinguish a world where $100 widgets are the only offer from a world in which a $90 widget is also available. She considers that the delay of one round-trip of haggling is worth $10 times the probability of a lower offer existing.
(Other factors obtain, too, like minimizing regret — if she bought a widget for $100 and then immediately saw Bob sell one to Faye for $90, she’d feel like $10 worth of fool.)