1 We now consider the treatment and interpretation of consumer surplus when there are changes inpopulationsize and inper capita real income, whenenterprises producing similar goods already exist, and when there are changes in people’s taste over time.
2 When estimating the demand curves over the future for goods to be provided by new investment projects we must make allowance for the growth in aggregate real income and its distribution.
Ignoring considerations of military or political power, a rise in population with-out any rise in real per capita income is not generally thought of today as conferring an increase in social welfare. Nonetheless, the resulting rise in demand for goods does operate to increase consumer surplus as defined and, consequently, may even-tually make economically feasible particular projects that would, in the absence of populationgrowth, remaineconomically unfeasible.
Infact, populationgrowth and growth of per capita real income are the two components of aggregate economic growth and, together, contribute over time to the apparent growth of social benefits arising from any investment project that is currently undertaken. Clearly, the expectations of such growth-induced benefits must be taken into account by the economist, who is required to declare in advance the average rate or future patternof aggregate economic growth onwhich his calculations are to be predicated. Having adopted some acceptable pattern over time of aggregate economic growth, he must then determine the way in which this economic growth will affect the magnitude of the benefits conferred by the goods that are to be produced by the investment project(s) under examination.
For example, inthe absence of any expected growth in the economy, a hypo-thetical investment of 100 this year is expected to yield an annual stream of real benefits of 10, 10, 10, . . . , 10, ignoring the question of uncertainty. Allowing for an annual average growth rate of aggregate real income of 4 per cent, and assum-ing an income elasticity of unity for the goods produced by this investment, it becomes necessary to revise the annual stream of benefits to something like 10.4, 10.8, . . . , 10 (1.04)n, the nth year being the terminal year. Indeed, as indicated, the investment may prove to be economically unacceptable in the absence of such a rate of growth of aggregate demand.
QUAH: “CHAP06” — 2007/1/25 — 08:01 — PAGE 40 — #2 This appears to be straightforward enough wherever a unique project is at issue such as a tunnel under the Severn river, a bridge over the Channel or a new national park. For such projects will not, over the foreseeable future, be ‘threatened’ by rival projects of a like nature. In such cases, growth in population alone (ignoring, that is, any increase in per capita income) will act to increase the demand for the services of such projects. The value of such services will grow, then, simply because the same service is being provided to more people. The bridge or tunnel or national park will accommodate an increasing number of travellers or visitors per annum – up to some point without an increase in current costs of upkeep.1
As for growth inper capita income inthe absence of populationgrowth, the increase in the usage of such newly created assets is less certain. For example, it may be the case that very few people will demand more park visits in response to a continuing rise in their incomes. Nevertheless, even if a person pays no more visits to a national park as he becomes richer, the value he places on the same number of visits will ‘normally’ – that is, if his income (or welfare) effect is positive – increase over time. This is not because his annual visits to the national park necessarily provide him with more utility as he becomes richer, but simply because the maximum sum he is prepared to pay for the same number of visits is higher when his real income is higher. Making our calculations on the basis of constant money prices over time, any rise in the value of benefits over time for all such reasons must be entered into the calculations.
3 Consider now the situation when one or more enterprises are similar to that being contemplated. The demand for the goods from, and the returns to, the existing enterprise(s) will be diminished by the introduction of the project in question. In what way should we allow for this?
Suppose the issue is that of building a bridge A now, bearing in mind that another such bridge B may be built a few years hence. If this later bridge B is built in response only to the growth in traffic – itself a result of the growth in population and in per capita real income – no problem arises. But if bridge B is to some extent competitive with the original bridge A, two questions must be faced:
first, whether bridge A should be built at all if it is expected that a competitive, and possibly superior, bridge B will be built at a later date. Second, if it does appear economically feasible to build bridge A today, notwithstanding the later introductionof bridge B, whenshould bridge B be introduced?
Concerning the first question, the alternatives to be considered are those of introducing bridge A today and of building bridge B at some later date, where the sizes or constructionof the two bridges canbe varied, as canalso the date at which the chosen bridge B is to be introduced. If the number of discrete variations in the timing and the size of the bridges are large, so also will be the alternative
1 We are ignoring the eventual costs of congestion as numbers increase. These are adverse spillover effects or external diseconomies that fall on the users themselves of tunnels, bridges and national parks, and they are discussed insome detail inPart III.
QUAH: “CHAP06” — 2007/1/25 — 08:01 — PAGE 41 — #3 Consumer surplus when other things change 41 combinations, each such combination being regarded as a distinct and separate investment project. The object of the exercise – obviously, a somewhat tedious and time-consuming business – is to choose that combination which, on a net benefit criterion, is ranked above all others.
As for the second question, once bridge A is already in existence, the building of bridge B can be justified only when the benefits over time from building it – as measured by the expected consumer surplus of its users – exceeds its capital costs. And it does not matter whether the traffic expected to make use of the new bridge B is so great as to leave bridge A devoid of traffic. In economics, bygones are bygones. Bridge A has already been built; the capital sunk into its construction is irrecoverable. What matters now is whether the variable costs of bridge A could still be covered, otherwise bridgeAshould close. We need compare only the capital cost of building a new bridge B with the expected benefits over time, given that bridge A is still available.
The demand schedule for the use of bridge B is that which provides us with a measure of the community’s benefit to be reaped by incurring the required capital expenditure. The area under the relevant demand curve that is above the variable cost of maintaining the bridge can be taken as a measure of the consumer surplus conferred by bridge B – being interpreted as the maximum sum above this variable cost that users of the bridge are ready to pay whenthey already have bridge A at their disposal.
4 Let us now move on to consider shifts in demand, and therefore of consumer surpluses, when there is a movement over time from one area to another, say from Londonto the Brightonarea. Clearly, anincrease inthe investment insocial capital, especially inpublic utilities, will be required inthe Brightonarea at the same time as existing social capital in London falls into disuse. If we suppose that, prior to the exodus, the amount of social capital was just right in both places, a prospective shortage of 100,000 houses inBrightonwould be matched by a prospective vacancy of 100,000 houses in London. There would also be a need to extend schools, build roads, invest more in transport, electricity, gas, water and telephones, and provide additional distributional services in Brighton, all of which would require additional capital, while the equivalent capital investment in Londonwould become superfluous. Clearly, it would have beenmore economical of society’s scarce resources if the desire to move to Brightonhad not occurred, for thenthe existing social capital stock would have sufficed.
But, once this change has occurred, the economist is concerned only with ways of meeting it efficiently.
Once social capital is irretrievably sunk in the London area, nothing can be done about it. In the light of existing demands, unwanted capital facilities become useless. All that matters now is the economic feasibility of building a new social capital in Brighton, where it is wanted. We must, therefore, compare only the additional capital outlays in Brighton with the magnitude of the expected ben-efits over the future as measured by the demand schedules for the extra services inquestion.
QUAH: “CHAP06” — 2007/1/25 — 08:01 — PAGE 42 — #4 However, what the migrants into the Brighton area are willing to pay for the services will depend, among other things, on what they are compelled to pay for them inthe Londonarea. Only if they had to pay more thanthe marginal costs of public services in London could the amounts they would be willing to pay inBrightonbe accepted as a correct measure of the benefits there. Indeed, anideal allocative procedure would require that the managers of these service industries (public utilities and the like) be ready at all times to reduce the charges for such services to no more than the current marginal costs of providing them, rather thanlose a customer. If the economy actually worked inthis way, the services of the economist could be dispensed with in such circumstances. But as it is difficult to discriminate between customers in this way, and as extending a reductionincharges made onbehalf of one customer to all other customers involves the company in losses of revenue – such losses being, in effect, transfer payments from the company to its customers – the customary charges (which are generally in excess of marginal cost) are generally maintained.
If this is so, however, it follows that the choice of moving from London to Brighton is being made on the wrong terms, for if, by reducing the charges of one or more of such public services until it is nearer to the marginal cost of its provision, a number of such ‘emigrant’ families can be induced to stay on in London, then a potential Pareto improvement can be effected: everyone concerned canbe made better off as compared with the alternative situationinwhich such families move to Brighton.2The ideal experiment is not to allow any family to move from Londonto Brightonwithout first offering it the optionof buying all such existing services at their marginal running costs. If, when such terms are offered to potential migrants, they are still willing to move and to pay for all newly required public services prices which cover their inclusive costs, all well and good.
Unless marginal cost pricing is already established in the public utility sector, such an ideal experiment – call it option 1 – is likely to run into administrative and political objections. For the costs of discovering potential migrants and of offering them special marginal cost terms without arousing the suspicion and hostility of other households canbe prohibitive. If, however, option1 is adopted, and all potential emigrants from the London area are presented with special permits enabling them to buy public utility services at their marginal costs, their demand schedules for any such service, say electricity, inBrightonwill be based ona ceteris paribus clause that includes a price for electricity in London equal to its marginal cost.
If this conditioncanbe met, the installationof an(additional) electricity plant inBrightoncanbe justified only if (measured, say, onanannual basis) the total
2 If the price per unit of electricity charged by the London supplier yielded an excess over its variable cost of $100 for the amount used by family A, aneffective bribe of less than$100 that induced family A to remaininLondonwould make both parties better off thanthey would be if family A moved to Brighton.
QUAH: “CHAP06” — 2007/1/25 — 08:01 — PAGE 43 — #5 Consumer surplus when other things change 43 revenue from the sale of the additional electricity along with the consumer surplus exceeds in total both current and overhead costs.
The economist, however, may well have to accept as a political constraint the existing prices set by public utilities in London and to calculate the bene-fits from extending them in Brighton by reference only to the resulting demand schedules.
5 Life would be less trying for the economist if people did not change their tastes so oftenover evenshort periods of time, as they habitually do ina modern economy. Such changes are not always rational: they may spring from trivial causes or be inspired by ignoble motives – greed, envy, the desire for attention or for being in fashion. It is no part of the economist’s brief, however, to uncover or to judge people’s motives inthis respect. He has perforce to accept as basic data the individual’s choices or revealed preferences at any particular time.
As already indicated, allowance can be made for a growth in benefits over time arising from increases in population and per capital real income and also for the introductionor withdrawal (whenthey canbe foreseen) of goods or bads associated with the operation of subsequent enterprises. Tastes may also change spontaneously or in response to advertising campaigns.
In so far as he cannot foretell such changes, the economist, if he is to make estimates at all, has perforce to project current valuations into the future in the knowledge that (to that extent) they are vulnerable. However, for public projects designed to improve the environment, to reduce pollution or to increase amenity, the valuation of their benefits is not likely to change significantly – at least not to fall significantly – with the passage of time. What is more, the economist’s confidence in his findings will grow if his calculations of the criterion V > 0 is met in a so-called sensitivity analysis that involves variation in the magnitude of key parameters.
6 Although there canbe justificationfor a programme that spreads accurate and useful informationwithinthe community, it is doubtful whether such justification can be extended to campaigns designed to change people’s tastes for no good reason. Part, at least, of the expenses of a commercial advertising agency is directed into an attempt to alter the existing patterns of tastes among potential buyers so as to favour the sale of goods supplied by their clients. Can there be any benefit to society of employing resources for this purpose?
If purely spontaneous changes in people’s tastes that are in no way related to dependable information necessarily incur wastage of resources, so a fortiori do commercially induced changes.And if, under existing political institutions, society permits scarce resources to be used expressly for the purpose of inducing changes in taste, then society is indeed countenancing the incurring of avoidable waste. In a dynamic economy where tastes are being manipulated by agencies, success in shifting the demand for a good x to that for good y, thenfrom y to z, thenfrom z to w and, possibly, from w back to the original good x – which changes, we can suppose, would not have occurred in the absence of advertising expenditures – then
QUAH: “CHAP06” — 2007/1/25 — 08:01 — PAGE 44 — #6 idle capacity is prematurely brought about inthe productionof each of these goods.
An unnecessary rate of obsolescence is created. The economist who remains neutral inthe matter of people’s tastes may properly conclude that avoidable waste is the price paid for the acceptance of persuasive advertising. This wastage of resources is, of course, passed on to the community at large through the higher prices needed to cover the higher cost of more rapid obsolescence.
QUAH: “CHAP07” — 2007/1/25 — 07:59 — PAGE 45 — #1