Saturday, April 27, 2013

A thought about consumer surplus and the measurement of national development.

Consider the standard diagram of supply and demand one might find in any textbook on economics.

The market clears when no consumer is willing to pay more than some seller is willing to sell the item in question. The consumer surplus is the total of the value of materials purchased by the consumers in excess of the price that they pay for what they bought. The producer surplus is the total of the amounts received by sellers over that which they valued that which they sold.

Now consider what happens when it becomes possible to produce at lower unit costs.

There is a shift in the supply curve, and assuming that there is no shift in the demand curve, the consumer surplus increases. That is, all the people who would previously have purchased the product at the higher price still purchase it, but at a lower price -- the surplus for each presumably increases. In addition, there are new buyers who now also receive a consumer surplus.

The contribution of the market transactions to the GDP are the total quantity sold times the price at which it is sold. Depending on the shape of the demand curve, the improved efficiency of production may increase or decrease the contribution to GDP. In either case, more sales at lower prices increase consumer surplus.

Water Supplies

In poor countries, drawing water is a big problem. People spend a great deal of time going to streams or pumps and carrying heavy loads of water back to their homes for drinking, cooking and washing. Of course, this doesn't enter the calculations of GDP since the people drawing water (usually women or children) are not paid for their labor.

When water is piped to the home, it becomes available at nominal cost. The labor that was formally used to carry water is freed for other work (or school) and there is only a small cost in keeping up the system. Water use goes way up. People are able to use more water. Indeed, the burden of disease goes down. People can not only drink more, use more water in cooking and in washing dishes and themselves, they can use water to wash floors and water plants. Consumer surplus goes way up. However, it is not measured in any national accounts.

Can We Measure Consumer Surplus?

I suspect that the true measure of progress is more related to the accumulation of consumer surplus than to the growth of GDP. How are we to measure that progress?

One measure is probably the extension of life expectancy. The longer we live, the more time we have to enjoy life.

One problem is that we have decreasing hedonic returns to scale. The more food we have, the less we value increasing amounts of food; indeed, if we have more than we can eat we have to spend time and effort disposing of the waste food. We are willing to pay more for better food, and to some degree we are willing to pay more for more nourishing food. People, as their incomes increase, spend more on meat, eggs and dairy products. Unfortunately, we also pay more for foods that are bad for us.

Another problem is that there are many aspects of life that we enjoy but don't pay for. Think of leisure, learning and enjoyment of family life.

Maslow's Needs Hierarchy

Perhaps we could develop a measure of development based on Abraham Maslow's ideas of a hierarchy of needs. Some measures that would allow plotting of how successfully the population of a country was fulfilling each layer of needs might be a much better (multidimensional) measure of development than per capita GDP.

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