The Surplus
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The US economy produces an amazing number of different products: thousands
of different foods, countless movies, dozens of different type cars, hundreds of
entertainment products, dozens of different type dog food, and on and on.
More than 25 million businesses produce these goods and services while 275
million consumers purchase them.
In addition, thousands of government entities at the local, state, and federal
level interact in various ways with these millions of businesses and consumers.
At the same time, 140 million people work as employees. Thousands of
different jobs exist in the economy: nuclear scientist, dog catcher, philosopher,
waitress, manual laborers, and so on. Many others, however, experience
unemployment.
This economy is spread over a vast geographical region containing areas as
different as Hawaii, Alaska, Nebraska, Florida, and California. Finally, the U.S.
is linked with the other nations of the world through trade and financial
connections.
Because if this complexity and vastness, it is hard to make sense of the US
economy.
But we can gain insight into the US economy—or any economy—by using a
few simple tools that come from economic theory. These tools help us identify
the key features of the economy. Once these key features are identified, we can
focus our attention on these few features instead of being overwhelmed by the
millions of separate components of the U.S. economy.
The most important of these theoretical tools is the simple and powerful
idea of the “surplus.” This chapter explains the concept of surplus.
PRODUCTION
People using materials and tools produce all goods and services created within
an economy. “Production” is the term we use to refer to this process: people
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THE SURPLUS
transforming raw materials into goods and services by their use of tools and
machines. Without people, production does not occur. This is a simple
observation, but it becomes very important when we consider any particular
economic system.
The number of people, their relationship to each other, the nature of the
materials used, and the type of tools used in production vary widely, of course,
depending on the product made, the geographical area, and the time period in
which production occurs.
For instance, today shoes are made with materials such as rubber, plastic,
various synthetic fabrics, and glue and are assembled by relatively unskilled
people using very complex and powerful shoe-making machines.
Two hundred years ago, however, shoes were made with leather, wood,
various natural fabrics, and nails. The skilled craft workers making these shoes
used relatively simple hand tools to assemble the shoes.
But in both periods, the production process involved people using materials
and tools made shoes. The same is true for every other production process.
THE SURPLUS
When production occurs the possibility exists that the economy will produce a
surplus. The surplus is simply defined.
SURPLUS DEFINED
The outcome of production is a set of goods or services. Further, a particular
production process leads to a certain amount of output: 100 shoes, 14 cars,
200,000 books, and so on.
A “surplus” exists if the amount produced exceeds what is used up in
production. The surplus product can be for a single production unit or for
production units all making the same product (say, all production units within
the “shoe industry”). Or, the surplus might be the total surplus produced
within a whole economy or country.
More precisely, a surplus exists whenever the direct producers in the
economy produce more than is needed to maintain them and to replace the
materials and tools used up in production. In some sense, the surplus is what is
“left over” after all inputs used in production are replaced.
EXAMPLE: SURPLUS PRODUCT IN A CORN ECONOMY
Suppose you have an economy that produces only corn. Suppose also that those
who live within this economy accept this because (in this hypothetical economy)
THE SURPLUS
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corn can be used both as food and as seed for the following year’s planting. I
will also assume that the tools needed to plant, take care of, and harvest coin
addition, are made of corn (corncob hoes?). This is not realistic, of course, but
it makes the story simple.
The economy starts with 10 bushels of corn. The direct producers plant the
corn and take care of it (weed, get rid of pests, and so on) by using their
corncob hoes. The direct producers are those who do the work in the economy.
Part of a Modern Corn Economy?
At the end of the growing season, the direct producers harvest the corn and
discover that they now have 40 bushels of corn. Figure 1-1 illustrates the
outcome of this production process: production—people using tools and raw
materials—transformed 10 bushels of corn into 40 bushels of corn.
Figure 1-1
production
10 bushels
40 bushels
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THE SURPLUS
In this economy, you can determine the surplus in a straightforward way.
You begin with the output you have: 40 bushels. You then subtract what was
needed to produce this output.
The material used (seed) was equal to 10 bushels. Suppose also that the
direct producers used as tools in this production process 10 corncob hoes.
However, not all of these hoes were used up in production during the year as
some can be used the next planting period. Some of the hoes, however, might
have been damaged and/or might have suffered ware-and-tear. I’ll assume that
2 bushels of corn were needed to repair/replace these hoes. In this case, we can
say that 2 bushels worth of corn was used to replace tools used up in
production.
Finally, let’s say that 23 bushels of corn was given to the direct producers.
They have to eat after all.
Table 1-1 shows that the surplus product of this corn economy is 5 bushels.
From the 40 bushels of output you subtract all the deductions mentioned above
(initial material, tools used up in production, what goes to the direct
producers).
Table 1-1
Surplus in the Corn Economy
Harvest
40 bushels
Minus
Initial materials
Tools used up
Going to Direct
Producers
10 bushels
2 bushels
23 bushels
Equals
Surplus product
5 bushels
EXAMPLE: SURPLUS IN A MONETARY ECONOMY
The above example used physical quantities (bushels) to measure inputs and
outputs. It is possible to restate the above example by using monetary terms:
that is, using dollars as our measure of quantities.
THE SURPLUS
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Not every economy uses money. But we will assume that our corn economy
above does use it. Suppose a bushel of corn is worth $10.
In this case, the production process described above can be represented
using purely monetary terms as in Table 1-2. The surplus is now equal to $50.
Table 1-2
Surplus in the Monetary Corn Economy
Harvest
$400
Minus
Initial materials
$100
Tools used ups
$20
Going to Direct
Producers
$230
Equals
Surplus
$50
DOES A SURPLUS ALWAYS EXIST?
In both examples above, a surplus existed. The output was large enough to
cover initial materials, the tools used up in production, and what went to the
direct producers. Something was still left over: the surplus.
No real-world economy and no real-world production unit, however, are
guaranteed to have a (positive) surplus. For instance, an economy might find
that their surplus is zero: the output produced merely equals what is needed for
production. Or, an individual production unit might find that it has nothing left
over after replacing everything used in production.
An economy—or production unit—could also end up with a “negative
surplus.” A negative surplus exists when the output falls below what is used up
in production. Something used in production is not able to be replaced. Such an
economy—or production unit—is likely headed for troubles.
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THE SURPLUS
Three Ways of Looking at the Surplus
Surplus = Output minus what is needed for
production
Surplus = Output minus (Initial Materials + Tools
used up + What Goes to Direct Producers)
Surplus = Value of Output minus (Value of Initial
Materials + Value of Tools used up + Value of What
Goes to Direct Producers)
THE SURPLUS, ECONOMIC GROWTH, AND ECONOMIC
DISASTER
The hypothetical economy discussed above had a surplus. After a year of
production it had more than it stated with. The surplus was 5 bushels of corn,
which was equal to $50 in our monetary economy.
At the beginning of the next year, the economy has 15 bushels of corn
available to it. Of this, 10 bushels came from being set aside to replace the
starting pile of seed from the first year and 5 bushels of corn came from the
surplus.
Those who decide what to do with the surplus might decide to add the 5
bushels of surplus to the other 10 bushels which has been set aside for planting.
In this case, the economy now has 15 bushels of seed to plant instead of the 10
bushels planted in the previous year. When the surplus is used to increase the
amount used for production this is called “reinvestment.”
If the surplus is used in this way, the harvest in the next year should exceed
the harvest of the previous year. If in the first year, 10 bushels of seed led to 40
bushels of corn, then in the second year it is likely that 15 bushels of seed will
lead to 60 bushels of corn. Such a growth in output is characterized as
“economic growth.”
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Alternatively, perhaps the surplus is used not to increase the amount planted
but is used to pay people to find better ways of producing corn or to invent
better corncob hoes. If these people are successful, perhaps productivity will
rise. Whereas before 10 bushels, 10 hoes, and 10 people lead to 40 bushels of
corn, now the same inputs leads to 50 bushels of corn. This is, again, economic
growth.
Or, finally, the surplus might be used to discover more inputs into
production. Perhaps it is used to discover new raw materials within the country
or it is used to go to other lands to find (or take!) what exists there.
If the surplus is used to reinvest into production, to find better ways of
producing the output, or to find more inputs, then economic growth will likely
occur. No guarantee exists that more will be produced (perhaps no one finds a
better way to grow corn or perhaps bad weather causes productivity to suffer),
but such use of the surplus makes it more likely the economy will grow than if
the surplus is simply buried in a hole in the ground.
Economic growth is more likely if a large portion of the surplus is put
back—directly or indirectly—into the economy.
The above discussion for an economy also holds true for individual
production units. An individual production unit can also use the surplus it has
in ways that lead to increased production for that unit.
Not all economies or production units produce a surplus. Some, in fact,
might experience a “negative surplus,” in which the output is less than what
was used to produce the output. Such economies are headed for trouble: they
might grow smaller and smaller over time as the negative surplus eats way the
inputs they use in production. Economic disaster is the likely fate of such an
economy.
Not all economies with surpluses—or even with sizeable surpluses—plow
back these surpluses into the economy. Even economies with sizable surpluses
might fail to grow or, at least, might grow very slowly. History is filled with
societies that disappeared because they failed to generate a surplus or, perhaps,
because they failed to put enough of the surplus back into the economy.
If an economy is to maintain itself over time, it must at minimum earn a
surplus equal to zero. Only if the economy has a positive surplus can it have a
chance of growing larger or of improving the material standard of living of its
citizens in the future.
Notably, societies that have prospered in history have generally produced
large surpluses. Most often a sizable chunk of the surplus made its way back
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THE SURPLUS
into the economy to promote an expanded economy. Often in century’s past the
surplus was used to expand geographically and to capture, by violence often,
the land, raw materials, and even people of lands far away.
Economic growth can reduce conflict. When the economy grows well, there
can be more for everyone. It is no longer the case that the only way to increase
your share is to reduce the share of someone else. Good economic growth might
permit more to go to the direct producers and more to be available for the
surplus at the same time.
Table 1-3 shows a growing economy and simultaneous improvements in the
standard of living and in the size of the surplus.
Table 1-3
Harvest
Replacement
To Direct Producers
Surplus
100
30
30
40
120
40
35
45
140
55
38
47
160
60
45
55
Of course, if economy growth stops or slow then conflict over how to split
the pie might become important once again.
MEASURING THE SIZE OF THE SURPLUS
THE ABSOLUTE SIZE OF THE SURPLUS
One way to measure “how much” of a surplus exists in a given economy is the
absolute amount of the surplus. For instance, the surplus might be equal to 10
bushels of grain or, say, $1,000.
In Table 1-2 the “surplus” appearing at the bottom of the table is the
absolute level of the surplus.
Everything else equal, larger economies are expected to produce more
surpluses.
Suppose, say, that every 10 bushels of corn planted leads to a surplus of 5
bushels. If economy A plants 10 bushels while economy B plants 100 bushels,
the surplus in A will be 5 bushels while the surplus in B will be 50 bushels.
With a larger surplus, economy B might have certain advantages over economy
B.
THE SURPLUS
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THE RATE OF SURPLUS
Often as important as the absolute size of the surplus is the rate of surplus.
The rate of surplus is the ratio of surplus to output:
Surplus
.
Rate of Surplus =
Output
In the example above, the rate of surplus was
5
Rate of Surplus =
= 0.125 = 12.5%
40
Table 1-4 below presents the rate of surplus for the corn economy and for
the monetary economy. The rate of surplus is the same in the two economies:
the addition of money to the economy does not change the rate of surplus.
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THE SURPLUS
Table 1-4
Surplus
Harvest
40 bushels
$400
Initial materials
10 bushels
$100
Tools used up
2 bushels
$20
Going to Direct
Producers
23 bushels
$230
Surplus (absolute level)
5 bushels
$50
Rate of Surplus
5/40 = 12.5%
$50/$400 = 12.5%
Minus
Equals
While the absolute amount of the surplus is one measure of the success of an
economy to generate a surplus, the rate of surplus indicates the speed with
which the surplus is growing. As such, the rate of surplus is a better indication
of the potential long-run growth of the economy.
WHAT DETERMINES THE RATE OF SURPLUS?
For a given sized economy, the rate of surplus will be larger:
• the greater is the level of productivity;
• the fewer/cheaper the tools used up in production; and
• the smaller is the amount going to the direct producers.
PRODUCTIVITY
Productivity measures how much you get from a given amount of input.
Productivity has increased if you now get more from the same amount of input
than you did in the past.
In the example above, 10 bushels of seed, 10 corncob hoes, and 10 people
produced 40 bushels of corn. If productivity improved, then these same
quantities of inputs would produce more corn, say 42 bushels of corn as
illustrated in Figure 1-2.
THE SURPLUS
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Figure 1-2
production
42 bushels
10 bushels
If productivity did happen to be 42 (rather than 40), then surplus would
grow. In Table 1-5, the changes following this higher productivity are indicated
in a different font.
Table 1-5
Surplus
Harvest
42 bushels
$420
10 bushels
$100
2 bushels
$20
23 bushels
$230
Surplus (absolute level)
7 bushels
$70
Rate of Surplus
7/42 = 16.7%
70/420 = 16.7%
Minus
Initial materials
Tools used up
Going to Direct Producers
Equals
The (absolute) surplus product is now 7 bushels and the surplus is now $70.
The rate of surplus in both economies is now 16.7%.
What causes productivity to improve? Better tools can lead to improved
productivity. The development of a more skilled labor force can contribute to
higher productivity. A better knowledge of how to grow corn can also lead to
greater productivity.
TOOLS USED UP IN PRODUCTION
If fewer tools are used up in production, more will be left over for the surplus.
For instance, suppose that only 1 bushel of corn was needed to replace/repair
the corncob hoes (instead of 2 bushels of corn needed in the examples above).
In this case, in the original example surplus product would grow from 5
bushels to 6 bushels. This is illustrated in Table 1-6.
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THE SURPLUS
Table 1-6
Surplus
Harvest
40 bushels
$400
10 bushels
$100
Minus
Initial materials
Tools used up
1 bushel
$10
Going to Direct
producers
23 bushels
$230
Surplus
6 bushels
$60
Rate of Surplus
6/40 = 15%
60/400 = 15%
Equals
Here the surplus and the rate of surplus grow due to the decline in what is
needed to replace tools that were used up in production.
What causes a change in what is needed to replace tools used up in
production? Perhaps stronger tools are invented that wear out more slowly or
break less frequently. Perhaps someone finds a way to make the same tool with
less input (say, a corncob hoe is now made with a little bit less corn than
before).
WHAT GOES TO THE DIRECT PRODUCERS
How much of the economy’s output goes to direct producers is often the most
important determinant of the size and rate of surplus. This is simply because
what does to the direct producers is often the largest single deduction from the
economy’s output.
How much the direct producers get is determined by many factors. These
factors vary widely over time and over space. For instance, the factors that
determined how much when to direct producers in 12th century England are
very different from those that determine how much goes to direct producers in
the 21st century United States. Certainly the amount going to the direct
producers in these two economies differs by a great amount.
Some generalizations, however, about what goes to the direct producers can
be made.
First, biology sets the minimum level for the standard of living. To survive,
people need basic things such as food and shelter. If the direct producers get less
than this biological minimum they die. No economy can survive in this
situation—who will do the producing if all the direct producers die?
THE SURPLUS
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Second, what goes to the direct producers generally exceeds the biological
minimum by a large amount. Social factors—customs and traditions—play a
large part in determining what and how much direct producers get. People not
only need clothes, they often desire fashionable clothes. People need food, but
they sometimes desire to go to popular restaurants. People might like
entertainment, but they might come to really want a DVD player because, well,
it seems to be a cool electronic goodie.
Third, past improvements in the standard of living often prompt people to
expect a continued future improvement in their standard of living. For instance,
when dishwashers were first available people saw them as luxury items: they
were certainly not part of the customary standard of living. Today, however,
many people think that a dishwasher is a necessity; they feel inconvenienced if
they don’t have a dishwasher. Once people cooked over open fires, then they
had stoves, and then microwave ovens appeared. While people in the recent
past might have been glad to prepare a dinner within an hour, today many
people believe themselves inconvenienced if they have to wait more than 15
minutes to prepare a complete dinner.
On the other hand, direct producers might under certain circumstances
come to expect that they will receive a lower standard of living. Perhaps they
are told they have no choice—they must accept a lower standard of living
because something bad has happened within the economy or because a greater
surplus must be generated for some reason. Or, perhaps the direct producers
are convinced that, due to forces beyond anyone’s control, they must accept a
lower standard of living for the good of all.
Fourth, the political and economic power of the direct producers directly
affects how much direct producers get for their contribution to production.
With sufficient power, the direct producers might succeed in getting a larger
amount of the economy’s output for their own. The power of the direct
producers is often a key determinant of the rate of surplus; I will we will return
to it in later chapters.
If the direct producers get less than before—and everything else remains the
same—the surplus will grow. For instance, if in the original example above
what direct producers get falls from 23 bushels of corn to 20 bushels of corn,
the surplus will rise from 5 bushels to 8 bushels. The rate of surplus will, as a
result, also grow. This is illustrated in Table 1-7.
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THE SURPLUS
Table 1-7
Surplus
Harvest
40 bushels
$400
10 bushels
$100
Minus
Initial materials
Tools used up
2 bushels
$20
20 bushels
$200
Surplus product
8 bushels
$80
Rate of Surplus
8/40 = 20%
80/400 = 20%
Going to Direct producers
Equals
If, however, the direct producers get more than before—and everything else
remains the same—the surplus will fall both in absolute terms and in percentage
terms.
CONCLUSION
The concept of the surplus is central to economic analysis. The success or
failure of an economy to generate a surplus is an important determinant of the
survival of this economy. A high rate of surplus can permit an economy to
grow; a negative surplus will lead an economy to eventually wither away.
Much can be learned about an economy by considering the various forces
that determine the size, and the use, of its surplus. But no economy can be
considered in isolation; all economies are part of a complex social system. As a
result, many other (noneconomic) factors lay behind the success or failure of a
given economy or society. Not every economy is organized along the same lines.
Ancient people had economies that differ greatly from most of those that
dominate most nations today.