Economic Surplus - Getting the Most out of Life

You're listening to Think Like an Economist, a Himalaya learning production. For exclusive content like bonus episodes and supplemental materials for this podcast and others like it, go to himalaya.com/econ and enter promo code E-con-E-C-O-N, a check out to get your first 14 days free. It's time. Think Like an Economist. Facebook had a typical value of about $500 per user. Now, there were some users, if you paid them $1, they would give up Facebook. There were others that you'd have to pay thousands and thousands of dollars. I'm Eric Bryn Joltzen. I'm a professor at Stanford and the director of the Digital Economy Lab there. The median user would have to pay $17,000 to stop using search engines for a year. Our friend and fellow economist Eric Bryn Joltzen studies the digital economy and how it's changing the world and the ways in which we economists do things. I think a lot of people take for granted a lot of these free goods and services we get. Now, there's always been free goods and services, whether it's television and radio or other things that we get to use for free. But more and more of the economy is digital, which means we're getting more and more free stuff through the internet and through our smartphones. We kind of take it for granted that this stuff is free, but it's a big chunk of the economy. One of the goals of our study is to make it more salient so we understand where the value is being created in the economy and we don't just take for granted all this free stuff. That's important not just for consumers, but I think it's especially important for policymakers and economists if you don't measure something, you tend not to value it. Eric and his colleagues, Avi Collis and Felix Eggers, use surveys to find out how much people value these digital services that so many of us use, appreciate and rely on, but usually pay nothing for. They ask people how much money they'd have to be paid to give up using social media like Facebook or search engines like Google. They are putting a price on our enjoyment of the internet. The results are really staggering. Even though it costs you pretty much nothing to use Facebook or Google, people say they've benefited a lot from using them. The work that Eric is doing is really important because he's highlighting a bunch of benefits that aren't otherwise measured. The enormous value you get from say, using Google doesn't show up in your spending because you don't pay any money for it. And while Google sells ads, the revenue it gets is only a fraction of the benefit you get. A lot of the value generated by Google will never show up in our economic statistics because it doesn't leave a financial paper trail. The economists call this economic surplus. Think about all the benefits you get from using Google. Now, we can take away what it costs Google to provide their service to you. What remains is economic surplus. Economic surplus is not just about the digital economy or unpriced goods either. You know that surge of joy you get when you're out shopping and you get a great deal, you get something for a much lower price than you had been willing to pay. That joy is coming from the economic surplus you're getting as a consumer. Economic surplus is the subject of this episode of Think Like an Economist. I'm Justin Wolffers. And I'm Betsy Stevenson. We're on a mission to teach you some economic super tools that you can use to radically improve your life. So, let's get stuck in. Nasturand Tavakoli Farr joins us. Hey there. So, Eric's points were really exciting for me because I'm a journalist and my industry has a very complicated relationship with the internet. Let me guess. People want to listen to loads of podcasts and read more articles than ever before, but they don't have to pay anything for it. Exactly. So, I was thrilled to hear that there's a way of actually putting a dollar figure on how much value people get out of listening to this podcast, for example, or reading an in-depth investigation on a news website or something similar. Yeah, there is a way we can put a value on it. Have you ever really looked at the things you own and asked yourself how much you value them? This sounds like Marie Kondo, like asking if my things spark joy. Yeah, but quantifying it, like what it's worth to you. Not in joy points, but in dollars. I bet you'll find that how much something is worth to you is very different to how much you paid for it, or even how much you could sell it for. We've learned that people only buy things when the benefit they get from it is more than the price they pay for it, and people only sell something if its price is more than its cost. But there can be a big gap between how much you're willing to pay and the cost to the seller. That is, there's a gap between the marginal benefit for buyers, which are high, and the marginal cost for sellers, which could be much lower. We call this economic surplus. When there's an economic surplus, both the buyer and the seller are better off from having traded with each other, and we can measure this surplus. For example, now as you collect records, right? I used to. I auctioned one of them off for our equilibrium episode. How much was it worth to you? Well, you know, I actually stopped actively collecting records, and the one I auctioned off, I mean, I liked it, but I didn't value it that much to be honest, so it was worth about $4 for me to keep it. And so I put it up for auction with a reserve price of $4. It ended up going for $16. Now as your marginal cost from selling the record is what it's worth to you to keep it. You apply the opportunity cost principle, and your next best option was to keep the record. At $4, you're indifferent between selling the record and keeping it. For less than $4, you'd rather keep the record. That's why you set a reserve price of $4, but you got $16. That's a lot more than $4. Your producer surplus, or in this case, your seller surplus, is the difference between what you got for the record, which is $16, and your marginal cost, which was $4. So your total producer or seller surplus is $12. It was an active auction, Katie outbid Chris, so we know it wasn't worth $16 to Chris. That's why he lost. And we know it was worth at least $16 to Katie. That's why she paid that much. But we don't know how high Katie might have been willing to go. Maybe she would have paid up to $25. Consumer surplus is the difference between your willingness to pay for something which represents your benefits and what you have to pay for it. If Katie had been willing to pay $25, but only had to pay $16, then her consumer surplus is $9. Economic surplus looks at how much you've both benefited from this trade, and it adds up your surplus. That's your producer surplus of $12, NAS, and the $9 consumer benefit for the buyer. Putting them together, there's $21 of economic surplus. It's kind of a miracle. That's the amount of extra joy that exists in the world because you sold that record to Katie. By getting the record to the person who values it most, the trade maximizes potential economic surplus. The biggest gap between the buyer's marginal benefit and your marginal cost happens when the record goes to the person with the highest marginal benefit. Economists call this an efficient allocation. That's a word you'll hear us use a lot. There's no outcome that would generate a bigger, combined consumer and producer surplus. Efficient is a really special word for economists. It means that we've made the total pie of well-being or welfare as big as possible. You see, it's not the price you sold the record for that matters. It's the fact that by trading it, you made the world a better place. Someone who values it more than you now has it. As a dictator, I could have taken the record from you, NAS, and given it to Katie. That would have made the world a better place too, but you might not have thought it was very fair. No, I'd have been really annoyed if you did that. Yeah, but Katie would have been really happy. By selling the record, you two shared the extra joy that was created in the world by trading. When economists are thinking about developing economies or economic growth or how to make the world a better place, they're thinking about the extra economic surplus or joy that could be created. The price is only a means to that end. That's kind of philosophical. I feel like we're about to debate capitalism versus socialism. Yeah, you know, economic surplus actually lets us have that debate. Can a system of socialism create as much surplus or joy in the world as possible or does a capitalist system do better? I'm going to need a beer before we can have that conversation. But it's important to know that maximizing surplus, having an efficient society that produces as much joy as possible, still misses some really important things like equity. I call this the Kim Kardashian problem. Hang on. What does she have to do with all this? Well, Kim Kardashian can afford to pay more. So her willingness to pay is higher just because she has more money. So she might not really love vinyl anywhere near as much as Katie, but her opportunity cost of money is so much lower, she might make an offer you can't refuse. An economist would say, hey, it's an efficient outcome. The record goes to the person willing to pay the most for it. But her marginal benefit doesn't just reflect how much she likes records or this record in particular, it's also driven by her income. You know, if incomes are really unequal, this might not be the best societal outcome. This isn't a huge problem for buying a record, but it is a problem if we are talking about something important like healthcare. I think I'm starting to sour on economic efficiency. Hey, Naz, don't give up on economic efficiency entirely. Consumer and producer surplus help us measure just how well off we can be, and it tells us a lot more than just prices can. Many of the things that create the most joy in our life, like access to clean water, indoor plumbing, technology that keeps us connected to friends and family, are a really small share of our budget, but a big share of our joy. So I'm struck by what Eric Brynjolfsson said earlier about how if we don't measure something, we don't tend to value it. The average American spends over six hours a day consuming digital media. So it's clearly a big part of their lives, and it needs to be a conventionally big part of our economic measurement. Economists look at GDP and productivity, which is based on GDP, to understand how the economy is doing. If you really want to know what people value, you need to look at something like consumer surplus and producer surplus. And ultimately, if you want to know how much value the economy is creating, we have to look at consumer surplus, not just production costs. And how about regular citizens like me? I'm definitely going to appreciate the stuff I buy and appreciate googling things more, but why is any of this important? Yes, you know, understanding your surplus is a bit of a gratitude exercise. Look at your life and all the things you have. What would you really miss if they disappeared? I actually asked Eric a bit about just this. Eric, is there a site or a service that is extremely valuable to you, like what site or service has the most consumer surplus for you personally? Well, like most people, I think the search engine is really something I couldn't live without. Wikipedia as well. I just am recovering from dengue fever, so I spent a lot of time on WebMD learning about the free medical information that we can have. One of my guilty pleasures is Twitter. And I probably spent too much time on that, but it's a fun way for me to debate with people like Justin and Betsy online and keep up with the latest economics. And how much would someone have to pay you to give up Twitter? It depends what mood I'm in. Sometimes I would give it up for free because I think it's a bit of a time waster. But other time, as my friends know, I spend an enormous amount of time on it, and I probably would have to be paid thousands of dollars to stop using it. So, I must say, economic surplus is helping me understand how much better off I am. Absolutely. Economic surplus can help you understand how much better off you are, but it also really helps when we start to think about economic policies. In later episodes, we'll start to see how markets fail. When economists say markets fail, they mean something really specific. That market outcomes don't maximize economic surplus. They aren't efficient. By measuring economic surplus, we can put a figure on exactly how costly the market failure is. That'll help us evaluate whether a public policy can make us better off in terms of does it create more surplus. We'll see that sometimes governments can succeed in helping to create more economic surplus. And sometimes we have government failure, where its regulations will actually reduce economic surplus. You know, sometimes the government reduces economic surplus by implementing bad policies, but sometimes the government reduces economic surplus on purpose because it wants to redistribute it. It wants to help people who have less have a little bit more. It wants to solve the Kim Kardashian problem. Economists do seem a bit obsessed with efficiency and equity, it's like deciding whether to have the biggest pie possible or the most equal slices. We heard in a previous episode that people respond to incentives and motivations. When everything is perfectly equal, no matter what you do, well people often can't be bothered. So then we don't innovate enough, we don't produce enough. Maximizing economic surplus is a little bit like maximizing incentives, but at some point the cost in terms of giving up equity is just too much. And it's important to realize there's not always a trade off between efficiency and equity. A really unequal society is one that also provides weak incentives and motivations for a lot of people because they come to believe that their hard work just isn't going to pay off very much. You know, and sometimes policies that prioritize equity, like access to education and childcare, also help grow the pie. They enhance economic efficiency, so not only isn't there a trade off, but the two go hand in hand. So we've been talking about surplus and efficiency and I think I'm starting to get it, but how should we summarize all of this? This is the measure of how well off we are as a society and whether there's anything else we can do to make ourselves better off. When the answer is no, we're at the point that economists call efficient. Economic surplus is the magic that comes from trading with each other. It's romantic. It's the extra joy we create from doing business with each other. Now, did you ever hear about that guy who traded a red paperclip for a house? Wait, what? That sounds crazy. He traded a red paperclip for a fish-shaped pen, which he then traded for a hand-sculpted doorknob and he kept trading until he got a rare snow globe, which he traded for a role in a film and he traded that role in the film with a town that really wanted a film and the town gave him a house. What happened was there was so much potential to create economic surplus by trading and he was able to harness that surplus to keep trading up until he had a house. That story is bananas. Every time I hear it, it reminds me how much economic surplus there is in the world. Economic surplus helps us understand that there's more we can do to make our lives and the world better. It also helps us quantify the loss of society from things like pollution. So we'll use this concept more in later episodes. And what can we practice to really understand this? So when you think how good your life is, don't just look at how much money you spend. Look at how much you value each purchase. How much joy you get from it. You know, if your goal is to help make the world a better place, you want to think about ways you can increase economic surplus or redistribute to people in the cheapest way possible. And if you can help grow the pie and make it more equally distributed, you'll have really succeeded in making the world a better place. Let's see, Justin. I'm going to start thinking about how much I value things. Thank you so much. Naz, it was great talking with you today. I hope you have a week full of surplus and gratitude. Thanks, Naz. To get the most out of this show, check out our bonus episodes and supplemental materials available only on the Himalaya Learning Platform. Himalaya Learning provides bite-sized courses from world-class thinkers and industry experts such as Arianna Huffington, Malcolm Gladwell, Tim Ferriss and more for you to enjoy in the app on the go. Go to Himalaya.com/econ and enter promo code ECON, E-C-O-N, a check out for your first 14 days free. It's time to think like an economist.