Our weekly explainer on economics using lessons from popular culture. In Installment 10, Richard Gere and Julia Roberts enjoy Consumer Surplus and Producer Surplus.
Pretty Woman is a timeless ’90s classic, unlike the ‘rom-coms’ of today, which are as predictable as the results of the 2019 Indian General Elections. Unfortunately, I don’t get paid to review movies (although it is a back up career option), so I’ll get straight to the economics lesson.
Richard Gere’s character in the film, Edward Lewis, is a rich corporate raider from New York who us sanskaari, untouched Indian men would call a ‘womanizer.’ Julia Roberts is the enchanting Vivian, a happy-go-lucky escort fancied by Edward. In a scene from the presidential suite of a premium hotel, Edward and Vivian are negotiating her price for the week.
“Full week, nights and days. It’s gonna cost ya 4000.”
“I would have stayed for 2000 you know.”
“I would have paid 4000.”
Edward paid US$1000 less than the maximum he was willing to let go for Vivian’s services, and Vivian received US$1000 more than the minimum amount she was willing to exchange her services for. Edward and Vivian both benefited from the transaction, and walked away with 1000 dollars of what economists call Consumer Surplus and Producer Surplus respectively. (The economist Alfred Marshall gave the concept its fame.)
Consumer Surplus is the difference between the maximum amount a buyer is willing to pay and the amount he actually pays. Let’s take another example: It is nine pm, and you have crawled through horrible traffic for the past hour after a nine-hour shift at work, where you survived two boring meetings. It is a hot day, and even night time temperatures reach 32 ̊ C. You have just arrived at your favourite watering hole, and can’t wait to have your first pint. How much would you be willing to pay for it? Given the situation, you will probably be willing to pay three times the actual cost, say Rs100, rather than do without it. You are thus enjoying a surplus of Rs200.
Just like the consumer, each seller has a minimum price at which he is willing to sell rather than not sell at all. The Producer Surplus is the difference between the market price and the seller’s least price at which they were willing to sell their products.
Economic surpluses are important to policy discourse because they aid our understanding of economic welfare, which is the total benefit available to society from an economic transaction or situation, and can be calculated by summing up the consumer and the producer surpluses. Thus it becomes a necessary thought experiment for regulators and businesses while deliberating on how goods and services should be priced with respect to the value they are creating.
A new paper by Steven Levitt et al (of Freakonomics fame) comes up with a pretty exact measure of how much UberX, the main Uber service in the United States, is improving the lives of its users. According to the paper, UberX produces a consumer surplus of about $6.8 billion a year in the US.
Such a data exercise becomes key in determining the social welfare created by Uber, and similar technology businesses that indulge in dynamic pricing across the world. They get a lot of flak from regulators for their alleged exploitative pricing, and the value they create is ignored. Richard Gere and Julia Roberts would have known just what I’m talking about.
And hey, just to make sure you get a surplus out of this article, here’s the title track of Pretty Woman.