This is one of the workhorses in the methods toolbox available to practitioners.
Consumer surplus is the gains obtained by consumers when they are able to purchase a product for a price that is less than the one they are willing to pay. Producer surplus are the benefits gained by producers when they are able to sell their goods and services for a market prices that is higher than the minimum they are willing to sell their product. Innovations may cause a shift in the supply curve through increases in yield or decreases in cost of production, which in turn may induce gains in producer an/or consumer surplus. Economic surplus is the sum of producer and consumer surplus.
The basic economic surplus model, as described by Alston et al. (1995), consists of a set of supply, demand, and trade equations that depict the market being analyzed. Algebraic manipulations of the basic supply and demand equations in the system allow derivation of formulas which allow estimation of total surplus and its distribution into producer, consumer, and innovator surplus.
As seen in the figure on the left, supply changes induced a change in prices and quantities supplied and demanded. Whether producer and/or consumers gain in the end depends of the structure of the system and the rate of change in the supply curve.
A typical formula to estimate producer surplus may look like this:
Change in Producer Surplus = Pw Q0 K (1 + 0.5 K ε )
Where Pw is the World Price and Q0 is the quantity produced, both before the adoption of the innovation, K is the relative amount that the supply curve shifts due to the innovation (directly tied to the yield and cost of production changes) and ε is the elasticity of supply. So, to calculate producer surplus the analyst basically has to multiply a set of parameters!!
Estimation of the economic surplus model in practice is done through the incorporation of equation parameters including size and openness of the economy, size of the sector demand and supply elasticities, shifts in the supply curve, adoption rates, and years for development and adoption.
Although the economic surplus approach has many limitations, is probably one of the most parsimonious method in terms of data requirements and which has a long history of use in terms of ex ante evaluations. The analyst can readily expanded and modify the model to include more sophisticated features such as the possibility of including stochastic parameters and using real option approaches to model risk.
Alston,J.M., G.W.Norton, and P.G.Pardey. 1995. Science under scarcity: Principles and practice for agricultural research evaluation and priority setting. Cornell University Press. Ithaca and London.
Some applications of the economic surplus approach
- Falck-Zepeda, J. B., G. Traxler and R.G. Nelson. “Surplus Distribution from the Introduction of a Biotechnology Innovation American Journal of Agricultural Economics. 82 (May 2000):360-369.
- “Introducing a genetically modified banana in Uganda : Social benefits, costs, and consumer perceptions.” 2008. Kilkuwe, Enoch; Wesseler, Justus, Falck-Zepeda, José. IFPRI Discussion Paper 767. Washington, D.C. International Food Policy Research Institute (IFPRI). http://www.ifpri.org/pubs/dp/ifpridp00767.asp,
- Falck Zepeda, J., D. Horna and M. Smale. “Distribution of economic benefits and risk from the adoption of insect resistant cotton in West Africa” 2008. African Journal of Agricultural and Resource Economics.