Lesson Transcript
InstructorKallie WellsShow bio
Kallie has a B.S. in Agribusiness and minor in Statistics from California Polytechnic State University, San Luis Obispo and M.S. in Agricultural and Resource Economics from University of California, Davis. She has extensive experience designing and performing economic analysis of wholesale energy markets and investigations of market participant behavior within these markets.
Economic benefits are defined as tangible benefits that can be measured in terms of revenue generated or money saved through the implementation of policies. Explore the definition and concept of economic benefits, surplus, and how net income is useful in determining new business policies.
Table of Contents
- What Are Economic Benefits?
- Surplus
- Net Income and Policies
- Lesson Summary
Economic benefits are benefits that can be quantified in terms of money generated, such as net income, revenues, etc. It can also be money saved when discussing a policy to reduce costs. How one measures economic benefits really depends on what he is analyzing. Economic benefits can be measured and used in business decisions, policy decisions, and market analyses. Businesses will probably use measures such as net income, net cash flow, or return on investment. Policy makers will likely use consumer and producer surplus measures.
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When discussing economic benefits of a particular market, measuring consumer and producer surplus is the common method. Consumer surplus is the difference between the maximum price one was willing to pay and what they actually paid. Producer surplus is the difference between what suppliers were paid and what they were willing to get paid for the good they produced. Each market has a supply and demand curve. Therefore, one can measure the economic benefit to consumers (consumer surplus) and the economic benefit to producers (producer surplus) in that market. The summation of consumer and producer surplus gives the total economic benefit to society from the given market. Let's assume the following chart shows the supply and demand curves for peanut butter.
The definition of a demand curve is the willingness and ability of consumer to buy a good at varying price points. Given the demand curve for peanut butter in this chart, there are some consumers willing and able to pay $10 for a jar. However, the market price, the price they actually have to pay, is $5.50. Those consumers that were willing and able to pay more for the good than what they had to, realize an economic benefit equal to the difference between what they would have paid and what they actually paid. So those willing to pay $10 have an economic benefit of $4.50, the difference between $10 and $5.50. The area under the demand curve and above the market price out to the market clearing quantity, represents the consumer surplus (blue shaded area) for everyone in the market.
Because the area in this example is a triangle, and the area of a triangle is equal to one half the base times the height, we can calculate the exact consumer surplus in this example. The base is 550 and height $4.50. Therefore 550 times $4.50 divided by two gives us $1237.50 as the consumer surplus.
The same type of benefit exists for the producers. The supply curve shows the willingness and ability for all producers to supply the good at varying price points. Some of the suppliers were willing and able to produce the good at $1 per jar, but were actually paid $5.50. The producer surplus, then, is the difference between the price they were paid for the good and the price they were willing to accept for the good. Those willing to be paid $1 have an economic benefit of $4.50. The area above the supply curve, below the market price and out to the market clearing quantity, represents the producer surplus (pink shaded area) for everyone in the market.
Here again, we can use the formula for area of a triangle to calculate the producer surplus in this example. The base is 550 and height $4.50, therefore, it is the same as consumer surplus, which gives us a producer surplus of $1237.50 as well.
The economic benefit to society as a whole from the peanut butter market in this example is the summation of producer and consumer surplus, the pink area plus the blue area. Given our calculations above, the total economic benefit is $1237.50 + $1237.50 = $2475.
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As mentioned previously, there are other measures besides consumer and producer surplus when talking about economic benefits. If a business owner is deciding between opening a new location, he or she will examine the actual costs of opening the additional location and the expected revenues over a given period of time. The economic benefit to that business owner would then be the expected revenues minus the costs, also known as the net income. Net income, or net cash flows, are the most common measures of economic benefits when talking about business and business decisions.
Another facet to measuring economic benefits is when analyzing the impact policies may have on society. This is more abstract than a business decision that has tangible revenues and costs. A policy could impact society on several different levels. For example, it may create additional jobs, which in turn generates revenues for families; generates taxes for the local city, state, and nation; and helps stimulate the economy. All the expected revenues generated from the action of implementing the policy are considered economic benefits. Note the benefits that may come from a policy change are not necessarily instant but may take several years to materialize.
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Let's review. Economic benefits are benefits that can be measured and quantified in terms of revenues generated as a result of some action. There are several different perspectives of how to measure economic benefits. Consumer and producer surplus measures are used in market analyses, while net income and impact on local and national economies may be measured in business and policy decisions.
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