Objections to total surplus as tool for welfare measurement

I think people would agree that the most common tool for welfare measurements in economics is the notion of total surplus.

Throughout it's history, total surplus has been criticized several times and on different grounds. This post aims at being a repository of all those critiques.

• Which are the critiques of total surplus which seem the most relevant to you?

Note : this is not meant to be a "total surplus bashing" repository. I believe some of the best critique of a concept like total surplus are rarely the one attempting to destroy the concept, and more often those which help us understand when it is best to use it, and when it might be better not to use it.

• Which definition of surplus do you have in mind? May 12 '15 at 10:24
• Total surplus = Consumer's surplus + Producer's surplus, where if $P^D$ and $P^S$ the inverse demand and supply, and $(q^*,p^*)$ are the (partial) equilibrium prices and quantity, CS = $\int_{0}^{q^*} P^D(q) - p^* dq$ and PS = $\int_{0}^{q^*} P^S(q) - p^* dq$ May 12 '15 at 12:35
• One obvious critique is that total surplus is only a partial equilibrium notion, but there are others and I would be interested in gathering a list here. May 12 '15 at 12:36

1 Answer

This is an answer to the closely related question of "why don't competition/antitrust authorities aim to maximise total welfare rather than consumer surplus?" There are a number of reasons for this:

1. If there are a small number of firms participating in a market then they have a very concentrated interest in that market and therefore have a large incentive to lobby for favourable treatment by a regulator. By contrast, it is likely that only a relatively small fraction of a consumer's income is spent in any one given industry and, therefore, each individual consumer has less interest in lobbying for consumers' interests in any antitrust proceeding. This leads to producers having a louder voice (a problem known as regulatory capture).
2. The total welfare and consumer surplus effects of a behaviour often point in the same direction (e.g. lower prices and higher quantities typically correspond to both higher consumer surplus and higher total welfare). If measuring both consumer and producer surplus is costly then measuring only consumer surplus will often be a sufficient heuristic.
3. There are information asymmetry problems insofar as firms have better information about their expected profit gains from a practice than do regulators. Producers are likely to overstate the private benefits of anti-competitive practices and the regulator would need to find a mechanism to induce truthful reveltation.

However, these points must be weighed against

1. Ignoring producer surplus understates the benefits of a practice and will lead to the prohibition of some practices that increase total welfare.
2. Firms are owned by people (i.e. consumers) so that the distinction between consumer surplus and producer surplus is, in some sense, a false dichotomy.
3. We should give firms enough profit to (a) cover the fixed costs of operating in an industry and (b) ensure that they have an incentive to innovate and be successful. If we insist on maximising consumer surplus by driving price to marginal cost then neither (a) nor (b) will be satisfied.