Patterico's Pontifications

2/4/2014

The Consumer Surplus and Income Inequality

Filed under: General — Patterico @ 8:47 pm

Now there’s a gripping headline! And look how long this post is! Next!

Stay with me anyway.

You know it’s a slow news day when the Hot Air quotes of the day are all about race and Jerry Seinfeld. I’ll pass on that particular controversy, although Noah Rothman does delightfully beat up a moronic Gawker writer about it here. Let’s talk about something else: the consumer surplus. (Woo-hoo!)

Why discuss that economic concept? Because I think the consumer surplus, and a couple of other economic concepts, reveal a lot about our current notions of “income inequality.”

Also, because it’s better than talking about whatever the stupid story of the day is. I listened to the “consumer surplus” concept discussed on a recent Russ Roberts podcast, and sometimes I think it’s fun to change things up on the blog by discussing things I have learned on one of his podcasts.

I’m not sure if you’re familiar with the notion of a “consumer surplus,” but the idea is that consumers often get far more value out of a good or service than they pay for it. Here is (in my view) a comically understated explanation from Forbes in 2012:

But TANSTAAFL [There Ain't No Such Thing As A Free Lunch] misses an important point: sometimes we can create value, not just move it around. Take the new iPhone 5. Recent reports put the cost of the components at $199 (for the 16 GB model), plus another $8 for assembly. The price to consumers: $649. This is a free lunch. Apple has taken $199 of parts and $8 of assembly effort and created something that consumers value in excess of $649. They have created more than $442 of value with every iPhone sold.

The consumers who buy the phone believe that they are better off with the new iPhone than with $649. Most of them would probably be willing to pay even more, say $659 or $699 to get the phone. This difference we economists call “consumer surplus.” It is the difference between the maximum that a consumer would be willing to pay, and the actual price the consumer has to pay. It’s immeasurable, but certainly a positive number. (If the consumer did not value the phone more than the money, he or she would not buy it.)

I have two completely contradictory reactions to that:

1. There is no way I would ever pay $700 for an iPhone. I just get upgrades, which are either free or cost me $100.

2. If I had to, I would pay waaaaaay more than $700 for an iPhone.

Contradictory? You bet . . . but bear with me. I think there are two principles at work here. I know the name of one of them, so let’s start with that one: the consumer surplus, which says that $649 is a great deal because the phone is worth so much more than that.

I am wedded to my iPhone, and it does all kinds of things for me. I surf the Internet for fun on it. I settle bets by referring to it. I get instant answers to things I wonder about by using it. I listen to podcasts on it. I listen to music on it. I listen to radio on it. I use it to text, take pictures, look at pictures, take videos, look at videos I made, look at videos on YouTube, illuminate objects, figure out the name of a song I hear, learn foreign languages, read books, give me directions to places (including finding my way around traffic), learn when music concerts I want to see will occur, wake me up, remind me of things, make notes, play games, watch live television, learn what the weather will be like tomorrow, make travel plans, time something, as a calculator, and probably a few other things I haven’t thought of.

Oh. And I use it to make calls.

If I had never bought one of these devices before, had never heard of such a device before, and had no idea what a device ought to cost, what might I pay for such a device? Probably thousands of dollars. A device that useful, with so many ways to make life easier, is simply incredible. I once paid well over $100 for a GPS. That’s just one of the many things this phone does. I have paid over $100 for an iPod. This thing can access the cloud and in that manner access far more music than even my 160GB iPod. The individual functions this device is capable of, added together in one small package, is easily worth thousands to someone who could afford it. To some, it might be worth tens of thousands, or more.

That is why the passage above is comical. I might pay more than $649? Maybe even $659?? or $699??????? No, I would probably pay over a thousand, easy. Easy!

That’s your “consumer surplus.”

Except, of course, there’s no way I would pay over a thousand dollars for one of these things. The idea of paying even $700 is ridiculous, but $1000 is unthinkable, for at least three reasons: 1) that’s not the price, and 2) I have never paid remotely close to that, and 3) I don’t know anyone who has paid remotely close to it.

Let’s look at some other things that are absurdly cheap to illustrate the point. I cringe at the idea of paying for an iPhone app. Why? Most are free. But if I do, it had better not be more than two bucks. Even if it’s a great app that will make my life better in countless ways, paying over two bucks is just shelling out too much money. (Excuse me for a moment; I have to pay the Starbucks guy for my coffee. Here you go, two, and there’s fifty cents, and another quarter is $2.75. Cheap for Starbucks, I know, but hey. I’m a simple guy.) So what was I saying? Oh yeah: paying over two bucks for a really super-cool app is ridiculous. Because most apps cost 99 cents or $1.99 at the most.

Similarly, I recently bought a giant mess of classical music, something like 16 hours’ worth, in an .mp3 format, for 99 cents. The quality won’t be high fidelity, and the performances may not be the Vienna Philharmonic, but I don’t know much about Haydn, and this will give me exposure to a lot of his music for less than a penny a track. But that Bach set for $2.99? Outrageous! It’s three times the cost, and it’s still only 15-16 hours of music!

Of course, there was a day when I would have considered $20 to $30 for such a collection of music on CD to be a bargain. And many of these apps are frankly worth way more than 99 cents. Mrs. P. has logged an embarrassing number of hours on some game called Plants vs. Zombies. I think it’s 99 cents, and I guarantee you she has paid less than a penny an hour for the privilege. But if she had been required to pay $5 for it? I don’t know if she would have gotten it.

And I would feel like a sucker if I found out that they had been giving away that Haydn set for a year, and jacked up the price to 99 cents the day I bought it. I got ripped off, man!

A ridiculous notion? Not really. So much of what we have access to is not just very cheap, it’s free. Russ Roberts and his guest pointed out that a fellow named Sebastian Thrun has made his intro class on artificial intelligence at Stanford available online. You can go take it right now. In fact, I might do it myself. It’s free. Through the Gutenberg Project, you have access to a lifetime of classic books, for free. I have paid scads of money in my life for piano music and musical scores, but I challenge you to think of something you can’t get for free here.

All of a sudden that CD Sheet Music set I got for $18.99 seems like an incredible ripoff. All of Schubert’s songs in one place? The equivalent of books I might have paid hundreds for? I can get that free on the Internet!

I sense two things going on here:

1. Our standard of living is greater than it has ever been, and countless conveniences and worlds of information are ours for a pittance. (Consumer surplus.)

2. If someone else seems to be doing better, or is getting their stuff just a little cheaper — or if we paid a little more now than we did in the past — we’re still going to be pissed off. (I don’t know the scientific or economic name for this, but in the Bible I think they call it “envy.”)

That, to me, is our “income inequality” issue in a nutshell.

Who among you would trade his life today, as poor as you may be, for the lifestyle of a king in medieval times? No Internet, no planes, no cars or trains or computers or vaccinations or central heating and air conditioning or running hot water or antibiotics or modern surgical techniques. The poorest person in America reading this Web site on his computer has a lifestyle outstripping those of most monarchs in history. But many of you (mostly lefties) are still bitching that someone else has it better.

That’s my long-winded response to the Barack Obamas who whine about income inequality. Just because someone else has it better doesn’t mean you don’t have it pretty damned good. So shut up and go enjoy something that this amazing world has made available to you for free.

48 Responses to “The Consumer Surplus and Income Inequality”

  1. Now, to start that artificial intelligence class…

    Patterico (9c670f)

  2. Except the whine about income inequality has nothing to do with income inequality. Everyone wants to be rich, but no one wants to pay the dues.

    Ag80 (eb6ffa)

  3. Interesting. I’ll have to sleep on it.

    gary gulrud (e2cef3)

  4. Little did we know, we’re pikers:

    http://www.livescience.com/40451-volcanic-co2-levels-are-staggering.html

    gary gulrud (e2cef3)

  5. gary @4: I heard that earlier today and meant to blog it. Thanks.

    I finished Unit 1 of the AI class btw.

    Patterico (9c670f)

  6. If someone can make an iphone for $500, they should go ahead and make their billion dollars doing it.

    It’s not just $199 in parts… it’s R&D and decades of building a brand.

    The thing is, I want Apple and Samsung to be able to make a lot of money making awesome devices. Because I like awesome devices, and the only way I get to have any is if someone has enough incentive to invent them.

    Just like with health care… I want awesome life saving advances in treatments and facilities, and the only way to get that is for that industry to be profitable.

    Some folks out there are constantly on the hunt for profitability as though that’s the enemy of social justice. I can only imagine all the cool stuff we don’t have today because of their efforts. Not only would poor folks have more cool stuff too, they would also be more likely to have a job. It’s really not a bad thing when someone else is wildly successful in our society.

    Dustin (f6642f)

  7. I admire the work and ingenuity that enables Starbucks to get $2.75 for a penny’s worth of polluted water, personally. And Phillip Morris for getting me to pay up to $10.00 a day for something that kills about 400,000 of its users in the United States every year. Consumerism.

    nk (dbc370)

  8. Who among you would trade his life today, as poor as you may be, for the lifestyle of a king in medieval times? No Internet, no planes, no cars or trains or computers or vaccinations or central heating and air conditioning or running hot water or antibiotics or modern surgical techniques.

    You make a good point, especially with the medical stuff. But on the other hand, how many kings would want to give up having subjects?

    Anon Y. Mous (8ec442)

  9. Who among you would trade his life today, as poor as you may be, for the lifestyle of a king in medieval times?

    If it meant I never had to see another Obama SOTU speech, I would in a heartbeat.

    Steve57 (71fc09)

  10. TL;DR…

    can someone tell me what this was about?

    redc1c4 (abd49e)

  11. Patterico likes his iPhone.

    nk (dbc370)

  12. For a very good explanation of consumer surplus, producer surplus, the supply and demand curves, and how, in limited circumstances, one can use price discrimination to try to squeeze those surpluses a little, read David Friedman’s Price Theory: An Intermediate Text which is usually available here, but his site appears to be down at the moment.

    Basically, as you said, consumer surplus is the difference between what you pay for something and what you would have been willing to pay. The reason the price isn’t as high as you were willing to pay isn’t just because the seller doesn’t know how valuable the product is. It’s because most people don’t value it quite as much as you do, and if the price was set at the maximum you would pay, too many other people would decide not to buy it.

    If it were possible, a vendor would like to charge each person what it’s worth to them; but even with telepathy this would not normally be possible, for a simple reason, which you allude to: even if you would be willing to pay $1000 for an iPhone, you wouldn’t pay that much because you can get it cheaper. In other words, if I, with my special knowledge of you, offer you an iPhone for a “mere” $900, you would laugh in my face and turn me down, even while admitting that it is worth more than that to you. You’d do that because the fellow down the street, who doesn’t know you that well, is willing to sell it to you for less, so why should you pay more? You like that consumer surplus, and there’s no reason you should give it away if you don’t have to.

    More than that: even if all vendors were telepathic, and could accurately determine how much an iPhone is worth to each customer, and charge them that much, it still wouldn’t work. Someone to whom they’re only worth $300, and who could therefore get them for that amount (remember, that’s still a lot higher than Apple’s cost) would buy them in bulk and flip them, making a fortune. So Apple has put a lot of research into finding the sweet spot where the revenue they lose from customers who value the iPhone at less than that price is outweighed by the revenue they gain from customers who value it at more than that price.

    But suppose it were impossible to sell your iPhone to someone else. Suppose the phone were so personalized to the purchaser that it would be useless to anyone else. Then a telepathic producer, who knew how much it was worth to each person, could charge every customer just $1 less than he’d be willing to pay, and grab all the consumer surplus for himself. That is called price discrimination, and there’s a lot of money to be made in it, if you can somehow get it to work. In some limited markets, something like it is possible, and therefore does happen.

    Read the book for the rest of this.

    Milhouse (b95258)

  13. Some folks out there are constantly on the hunt for profitability as though that’s the enemy of social justice.

    It is. “Social justice” is neither.

    Milhouse (b95258)

  14. Phillip Morris for getting me to pay up to $10.00 a day for something that kills about 400,000 of its users in the United States every year.

    That number is vastly exaggerated. It’s been a while since I’ve read about this, but if I recall correctly the more reliable numbers put the death toll at no more than 50,000 a year. Which is still terrible, but for some reason the health nazis feel a need to gild the lily.

    Milhouse (b95258)

  15. You make a good point, especially with the medical stuff. But on the other hand, how many kings would want to give up having subjects?

    What good are they, except to the extent that they let you have a good life? We have better lives without subjects than the Sun King had with them. He’d surely trade his life for ours, if he could.

    Milhouse (b95258)

  16. O/T, but apparently Ford sells this in Iceland.

    http://www.eureferendum.com/images/000a%20Iceland%20004.jpg

    Why don’t we get the good stuff? I want one.

    Steve57 (71fc09)

  17. Talk about inequality. Icelandic girls and six wheel drive Fords?

    It ain’t fair.

    Steve57 (71fc09)

  18. if you want a 6×6 truck, go here: http://www.easternsurplus.net/

    i’d kill to be able to afford, and own, an M-35A2 w/Winch & turbo. a gun ring would be nice too, since i’m dreaming. 8-)

    redc1c4 (abd49e)

  19. I appreciate the suggestion, but for some reason the M-35A2 doesn’t do it for me.

    Apparently that Ford E350 was built by an Icelandic company called Icecool for some South Pole Challenge.

    http://www.old.icecool6x6.com/index.php?option=com_content&task=view&id=28&Itemid=38&lang=en

    Here’s a couple more pics:

    http://www.4x4offroads.com/image-files/blue-lagoon-6×6.jpg

    http://s188.photobucket.com/user/expeditioncampers/media/ice-challenger-1.jpg.html

    I know the Icelanders build some cool trucks (pun intended).

    http://arctictrucks.com/

    Steve57 (71fc09)

  20. Thanks to Obamacare I’ll never be able to afford anything like that.

    Steve57 (71fc09)

  21. Back when we had such things as schools and teachers kids would have learned about the “consumer surplus” while they were learning about the elasticity or inelasticity of prices. Ah, well, c’est la vie.

    Concerning the “income inequality” meme, that’s a creation of Democrat power politics. An offshoot of politics by identities. There is no such thing as income inequality, at least not in the sense the Dems/media use that phrase. It’s the equilibrium of labor economics. A private utilitarian enterprise pays people what they’re worth to that enterprise and what the labor market bears for that marginal unit of labor.

    Ironically enough to the extent there are inequities in income they’re directly connected to public sector unionization, profligacy in public spending and Democrat politics. The waste case ex-Hippie teaching nonsense at UCLA, for example, but who’s being paid six figures in public money salary plus a defined-benefit public pension and vested public healthcare. The unionized prison guard who’s paid more than a scientist. So on, so forth.

    Lawrence Westlake (48fb95)

  22. This does not help the consumer choice argument, but you *have* in fact paid closer to $649 for your iPhone. Your service provider paid the difference to Apple for you, and locked you into a contract to extract that money from you over time.

    mcg (f42a4d)

  23. “Our standard of living is greater than it has ever been, and countless conveniences and worlds of information are ours for a pittance. (Consumer surplus.)”

    And yet there’s still scaremongers fearing inflation just around the corner.

    “That, to me, is our “income inequality” issue in a nutshell.”

    If you want to look at inequality you’d want to look at something like the Gini coefficient.

    d.wildst (ae20f1)

  24. Comment by Milhouse (b95258) — 2/5/2014 @ 12:16 am

    I believe you. I’ve caught them in other lies, too. But whatever works. Smoking is stupid. I’m stupid to smoke.

    On that point, I’ve started using a cigarette personal economy. For example, my daughter keeps losing her gloves and it upsets her mother. I replace them two pairs at a time, so she’ll always have a spare pair. A pair of nice Isotoners is two packs of cigarettes — I’ll smoke the money in two days if I’m not careful, certainly within four. I bought a nice London Fog park for about fourteen packs of cigarettes. (They wanted 25 packs for a Northface — what a ripoff. ;))

    nk (dbc370)

  25. Come to think of it I’ve a couple $1500 vacuum cleaners and a $1000 floor steamer. The $300 carpet cleaner is probably a better value than the steamer.

    25. I used to smoke Camel straights. Sometimes I miss them. Chew.

    gary gulrud (e2cef3)

  26. Lots of excellent comments. You guys are good.

    I’ve often opined that without women we’d have all these goodies, like 57′s trucks, but we’d be living in teepees.

    gary gulrud (e2cef3)

  27. 24. Ok, I looked. It needs work.

    http://en.wikipedia.org/wiki/Gini_coefficient

    Venezuela same as Canada. Right. Europe is t-minus 15 minutes and torched, scorched Earth.

    gary gulrud (e2cef3)

  28. The yen getting stronger means Market down again today. Gold surging to short squeeze point. Margin continues to wash out.

    gary gulrud (e2cef3)

  29. A need for a window of survivability, Chicago Trib:

    Mayor Rahm Emanuel’s administration is making preparations to issue up to $900 million in bonds this year to lower some of its borrowing costs, push other debt off into the future at an overall higher cost, cover legal settlements and pay for construction, building maintenance and equipment.

    At the same time, the administration is making plans to double the city’s short-term credit line to $1 billion, Chief Financial Officer Lois Scott told aldermen at a City Council Finance Committee meeting.

    Beat the next downgrade.

    gary gulrud (e2cef3)

  30. Keep quiet about this consumer surplus, or they’ll call it income and tax it.

    Kevin M (536c5d)

  31. I am wedded to my iPhone, and it does all kinds of things for me. I …

    That’s a funny thing I was thinking about… we look at these phones as “Star Trek Communicators”… and, indeed, the first consumer generations of them were, part of the reason why the “flip phone” design was so popular. It was an obvious nod to Star Trek’s iconic communicators.

    But along the way, we developed smart phones, which developed into so much MORE than mere (LOL!) “Star Trek Communicators”.

    No, the smart phone is actually the first generation of Star Trek TRICORDERS

    Think about it…

    Sensors to detect various physical values (my Samsung S2 has sensors for: Acceleration, Proximity, Magnetic Fields, Orientation, Gravity, Light)
    Location sensor via GPS
    Access to “the ship’s computer” (i.e., “the internet”)
    The capacity to analyze data (“There’s an app for that”)
    The capacity to store, sort, and organize data (“There’s an app for that, too”)

    How is this, really, any different from a Star Trek Tricorder? Sure the Tricorders in Star Trek were much more highly developed, but that was supposed to be over 200-300 years from now. Contrast the distinction between an 1814 ship’s compass and sextant with a GPS navigation system. I think we can reasonably expect STNG level “tricorders” within about 50 years…

    Smock Puppet, Gadfly, Racist-Sexist Thug, and Bon Vivant All In One Package (225d0d)

  32. Asking O-man to shut-up about something is preposterous.
    Community Organizers cannot stop talking, it is the way they reaffirm their relevancy in the their own minds.
    They are relevant as long as they talk about something, actually accomplishing something….
    now that is irrelevant.

    askeptic (2bb434)

  33. And Phillip Morris for getting me to pay up to $10.00 a day for something that kills about 400,000 of its users in the United States every year. Consumerism.

    Be much more impressed by an anti-smoking movement that can gouge you for thousands of dollars by
    1) Inflating that mortality figure by a factor of 4x to 6x and get you to believe it.
    2) Claim that YOUR smoking is costing society millions of dollars in “increased health care costs” despite the fact that it was also shown that society SAVED –FAR– more than those increased costs by reduced payouts of Social Security benefits.

    I mean, at least PM gave you a mild high in return for your money. WTF did the anti-smoking lobby give you?

    Smock Puppet, Gadfly, Racist-Sexist Thug, and Bon Vivant All In One Package (225d0d)

  34. But on the other hand, how many kings would want to give up having subjects?

    This is an unfair question, really.

    The real thing would be — allow them to spend six months under modern conditions, as a “plebe”.

    Then see how many would choose to go back.

    And how many, a week after going back, would still say “Yeah, I like this better.”

    Peeps have short memories. But the tuchus knows its discomforts.

    Smock Puppet, Gadfly, Racist-Sexist Thug, and Bon Vivant All In One Package (225d0d)

  35. Patterico,
    A couple flaws in your post.
    1. You’re probably paying way more than 649$ for you iPhone…or to look at it another way the interest you’re paying to borrow the money to buy the phone is a *really* high rate.
    2. The cost to produce the iPhone you listed doesn’t seem to include the engineering and development costs.
    That said I enjoyed the read.

    Time123 (066362)

  36. Nah. The only thing that makes those phones worth anything is the connection to the internet and you pay through the nose for that.

    Still, a better deal than Starbucks where you pay for err … you pay for … you pay for …. WTF do you pay for? It’s not even hip anymore. Conformity, because so many people do it?

    nk (dbc370)

  37. You pay to follow the current fashion.

    nk (dbc370)

  38. 26. About my vacuum cleaners:

    I sold a few when down on my luck, branded Rainbow. They provide an impressive air flow and take up anything lighter than marbles miscible with water.

    Since we are infested with cats, flushing the resulting mat of hair isn’t cost effective with a septic system so I pluck the mat out by hand.

    The water-filtered exhaust is dumped through a HEPA filter so micron sized dust, odor and microbiologics doesn’t just go right back into your air.

    For incinerated wood ash one must use a regular shop vac as the ash evades water filtration.

    gary gulrud (e2cef3)

  39. I’ve asked people that for years: would you give up keen living to be a super-wealthy person in the 19th century? Consider the infant mortality rate when deciding.

    Everyone says they would rather live now.

    Thank you, capitalism.

    bridget (87845c)

  40. I don’t know how Nixon got elected — nobody I know voted for him.

    nk (dbc370)

  41. And that joke by Pauline Kael was about the 1972 election!

    The actual original quote may have been this:

    I live in a rather special world. I only know one person who voted for Nixon. Where they are I don’t know. They’re outside my ken. But sometimes when I’m in a theater I can feel them.

    It was in a speech delivered at the Modern Language Association, on Dec. 28, 1972, and quoted in the New York Times. But it became:

    “How could Nixon have won? Nobody I know voted for him”

    Sammy Finkelman (dfe091)

  42. 42. All the same its the voter’s fault, e.g., given Nixon vs. McGovern, those exercising their citizen’s duty managed a crime against America.

    Why don’t we have a “throw them in the dumpster” option?

    gary gulrud (e2cef3)

  43. 1) Inflating that mortality figure by a factor of 4x to 6x and get you to believe it.

    More than that, if I recall correctly.

    2) Claim that YOUR smoking is costing society millions of dollars in “increased health care costs” despite the fact that it was also shown that society SAVED –FAR– more than those increased costs by reduced payouts of Social Security benefits.

    That too, but even confining ourselves to medical costs, smokers end up costing less than us non-smokers, because sooner or later we’re also likely to end up dying of something at least as costly as whatever kills the smokers, and in the meantime we’ll be consuming routine geriatric medical care for another decade or two.

    Milhouse (b95258)

  44. Still, a better deal than Starbucks where you pay for err … you pay for … you pay for …. WTF do you pay for? It’s not even hip anymore. Conformity, because so many people do it?

    What you pay for is a nice place to sit and read or work or surf the net. You don’t actually have to pay for that, but their business model is to let you sit for free, and figure that sooner or later you’ll get thirsty, and it will be far more convenient and comfortable to get their overpriced burnt coffee and return to your book or laptop, than to pack yourself up and go to a less comfortable and welcoming venue for cheaper and better coffee. It’s not intuitive, but it works.

    Milhouse (b95258)

  45. Starbucks where you pay for err … you pay for … you pay for ….

    46. Comment by Milhouse (b95258) — 2/5/2014 @ 10:12 pm

    …a nice place to sit and read or work or surf the net. You don’t actually have to pay for that, but their business model is to let you sit for free, and figure that sooner or later you’ll get thirsty, and it will be far more convenient and comfortable to get their overpriced burnt coffee

    But how is it that only, or mostly, coffee drinkers do that? If they don’t drink coffee, people feel guilty, ad don’t go in?

    They are also paying for not having to look for a place that sells coffee.

    Sammy Finkelman (dfe091)

  46. No, Milhouse is right. In Chicago, there are Greek and Italian coffee shops, have been forever, where you go have a demitasse, a biscuit, maybe a grappa or an ouzo, and read your newspaper and socialize. Usually nice, with table service and lace doilies on crockery saucers and plates — not cardboard. There was a nice Italian one I’d stop by once in a while — the younger people would show up in the evening in Ferraris and Corvettes, but it was still a neighborhood place with old guys just getting out of the house too. Starbucks is the lower-class, though not the lower-priced, variant of that, for faux hipsters who never experienced anything better in the cultural desert of Generation X.

    nk (dbc370)


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