Numéraire
Volume the Seventh · of the table of twenty-six
The Quantities · Group II · № 07 · Su

The Surplus

the value beyond the price

The surplus is the value an exchange creates beyond its price — the gap between what a thing is worth to the one who buys and what he actually pays, joined to the gap between what the seller receives and what it cost him to provide — and the volume follows that value from its making to its sharing. A price, taken alone, creates nothing; it is a transfer, as much a loss to one party as a gain to the other. What a market makes is the surplus around the price, and to measure it was the achievement of welfare economics. The volume opens with Harold Hotelling, who gave consumer surplus its rigorous grounding and proved that the total surplus is greatest exactly where price equals the cost of one more — the competitive point at which every value-creating trade is made. Frédéric Bastiat then locates the source of the surplus in voluntary exchange itself, where both parties gain by trading what they want less for what they want more, and warns that this gain, being real but unseen, is forever sacrificed to the seen — the broken window mistaken for prosperity, the protected producer shielded at the cost of every buyer. John Stuart Mill asks how the jointly created surplus divides between the two parties, and answers with reciprocal demand: the terms of trade settle where each side's desire for what the other holds comes into balance, turning against whoever wants the exchange more, so that eagerness is weakness and the power to walk away is strength. Edward Chamberlin shows how sellers manufacture that power through the differentiation of their products, each brand a sliver of monopoly that captures some surplus, only to see it competed away by entry into the waste of excess capacity. And the flagship gathers the threads. Abba Lerner states the rule that makes the surplus largest, price at the cost of one more in every industry; the index that measures the market power withholding it; and the contested argument for how the surplus, become a society's income, ought to be divided. In his terms the volume answers the question the author set it: an exchange creates value beyond its price — who walks away with it? The surplus is created jointly, made largest by competition, captured by power, taxed and reapportioned by the state, and partly lost to the trades that power and barrier forbid; its size economics can settle, its division it can only illuminate. With the surplus, the quantities are complete.

in print · № VII · 12 of 12 plates
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The argument of the volume

Begin with what the surplus is, for a price by itself creates nothing. When a thing is worth forty to a buyer who pays twenty-five, he keeps fifteen — consumer surplus, the gap between what a thing is worth to him and what he pays; when a seller takes a price above what the good cost him to provide, the excess is producer surplus; and their sum, the total surplus, is the gains from trade, the genuine value the exchange creates beyond the resources it consumes. The price is mere transfer; the surplus is the creation. Harold Hotelling gave consumer surplus its rigorous grounding as a measure of welfare and proved that the total surplus is greatest precisely where price equals the cost of one more unit — the competitive point at which every value-creating trade is made and none that would destroy value. And the source of the surplus, Frédéric Bastiat showed, is voluntary exchange itself: both parties gain by trading what they want less for what they want more, so that value springs from nothing but the difference in their valuations — a gain real but unseen, and therefore, as his parable of the broken window warns, forever in danger of being sacrificed to the visible interests it does not serve.

If the surplus is created jointly, how is it divided between the two who create it? The price draws the line, and what sets the price is the relative strength of the two parties' need. John Stuart Mill answered with reciprocal demand: the terms of any exchange settle where each side's desire for what the other holds comes into balance, and they turn against whoever wants the trade more, so that eagerness is weakness and the power to walk away is strength — the surplus flowing to the party who can most easily say no. A seller who would keep more of the surplus must therefore manufacture that power, and Edward Chamberlin showed how it is done. By differentiating his product — a brand, a name, a quality his rivals lack — each seller carves out a sliver of monopoly over the buyers who prefer it, and prices above the cost of one more, capturing some surplus. But the open door of entry competes the captured profit away, until it survives not as the seller's gain but as the waste of excess capacity, too many firms each producing below its efficient scale.

The flagship gathers the threads. Abba Lerner stated the rule that makes the surplus largest — price set at the cost of one more in every industry, under any form of ownership — and the index, the gap of price above that cost taken as a fraction of price, that measures in a single number both the market power a seller holds and the surplus that power withholds and destroys. To the hardest question, how the surplus, become a society's income, ought to be divided, he brought a celebrated argument from ignorance: that since we cannot know whose want a dollar answers more, and since the satisfaction of income diminishes at the margin, the division promising the most satisfaction is the equal one — bold, and contested at every premise, not least by the incentives that make the size of the surplus depend on how it is shared. In his terms the volume answers its question. The value beyond the price is created by exchange, made largest by competition, captured by power, taxed and reapportioned by the state, and partly lost to the trades that power and barrier forbid; its size economics can settle, its division it can only illuminate. With the surplus, the quantities are complete.

The argument remains open. What follows is an attempt to fix its exact edges.

The twelve plates of this volume

  1. i The Trianglein print Hotelling; consumer and producer surplus, the value an exchange creates beyond its price, and the welfare optimum where price equals the cost of one more. Read the plate →
  2. ii The Bridgein print Dupuit; the engineer who first measured the worth of a public work beyond the tolls its users pay. Read the plate →
  3. iii The Unseenin print Bastiat; the gains from voluntary exchange, real but unseen, and the broken-window fallacy that destruction creates no wealth. Read the plate →
  4. iv The Termsin print Mill; reciprocal demand and the terms of trade, the division of the gains turning against whichever side wants the exchange more. Read the plate →
  5. v The Brandin print Chamberlin; monopolistic competition, product differentiation buying a sliver of market power, the surplus captured then competed away into excess capacity. Read the plate →
  6. vi The Sortingin print price discrimination, the seller sorting buyers by willingness to pay to capture more of the surplus, the whole of it under perfect discrimination. Read the plate →
  7. vii The Lossin print deadweight loss, the surplus that simply vanishes when trade is held below its efficient level, captured by no one. Read the plate →
  8. viii The Controlin print Lerner; the economics of control, the index of monopoly power, marginal-cost pricing, and the contested rule for how the surplus should be divided. Read the plate →
  9. ix The Advantagein print comparative advantage, the gains from specialization even when one party is better at everything. Read the plate →
  10. x The Biddingin print auctions, mechanisms that assign the surplus by their rules, the winner keeping the gap to the runner-up. Read the plate →
  11. xi The Scramblein print rent-seeking, the surplus consumed by the resources spent fighting to capture it. Read the plate →
  12. xii The Capin print price controls, a ceiling or floor holding a price off its level, destroying some surplus and reshuffling the rest. Read the plate →

In closing

This volume took up the surplus — the value an exchange creates beyond its price, the gap between what a thing is worth to the one who buys and what he actually pays. Its subject was the genuine creation that a voluntary trade brings into being, as against the price, which only transfers; and it followed that creation from its source, through its division between the parties and its capture by the powerful, to the contest among buyer, seller, and state over who finally keeps it. The question the author set it was this: an exchange creates value beyond its price — who walks away with it?

The volume traced the surplus from making to sharing. Harold Hotelling gave consumer surplus its rigorous grounding and proved the total surplus greatest where price equals the cost of one more, the competitive point at which every worthwhile trade is made. Frédéric Bastiat located the source of the surplus in voluntary exchange, where both parties gain by trading what they want less for what they want more, and warned that this gain, being real but unseen, is forever sacrificed to the seen — the broken window mistaken for wealth, the protected producer shielded at every buyer's expense. John Stuart Mill showed how the surplus divides, the terms of trade turning against whoever wants the exchange more, so that the gain flows to the party who can walk away. Edward Chamberlin showed how a seller manufactures the power to keep more of it, differentiating his product into a sliver of monopoly — only to see the captured surplus competed away into the waste of excess capacity.

The flagship carried the contest to its resolution. Abba Lerner stated the rule that makes the surplus largest, price at the cost of one more in every industry; the index that measures the market power withholding it; and the contested argument for how the surplus, become a society's income, ought to be divided. In his terms the volume's question is answered: the value beyond the price is created by exchange, made largest by competition, captured by the powerful to a degree the index measures, taxed and reapportioned by the state, and partly lost to the trades that power and barrier forbid — so that who walks away with the surplus is contested at every step, its size a matter economics can settle and its division a matter it can only illuminate. With the surplus joining the margin, the utility, and the stock in print, the family of the quantities stands complete, all four of its elements in the table; and the quantities have their value beyond the price, the gain that all the measuring was finally meant to find.

The volume followed the surplus from its making to its sharing and found the sharing settled by power — the bargaining power of the parties, the market power of the seller, the taxing power of the state. But in tracing who captures the value beyond the price, it left unsettled whether any of them has earned it. Is the share that market power carries off the reward of some service the holder renders — the risk borne, the product devised, the capital advanced — or is it a toll exacted by position, a claim that power levies because it can? The surplus can be measured and its division marked; whether a captured surplus is deserved is a question of justice the accounting cannot reach, and the volumes of the power, the rent, and the share take it up. And behind it lies a deeper unease: that the very arrangements which make the surplus largest may not be those that divide it most justly, so that to maximize the value beyond the price and to share it well may be aims that pull against one another. The argument remains open.