How Continuous Innovation Affects Supply, Producer Surplus, and Consumer Surplus

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This Demonstration shows producer surplus (PS), consumer surplus (CS), and total surplus (TS) when there are parallel shifts in supply and divergent pivotal shifts in supply . Innovations that favor low-productivity/high-cost producers create divergent pivotal shifts in supply, which can be simulated by increasing the slope of the supply curve while keeping the intercept constant. On the other hand, innovations that create similar benefits to both the high-productivity/low-cost producers and low-productivity/high-cost producers create parallel shifts in supply. Rightward parallel shifts in supply can be simulated by decreasing the intercept of the supply curve while keeping the slope constant.

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Focusing on divergent pivotal shifts in supply, graphical simulations show that when there are divergent pivotal shifts, PS reaches a maximum when the slope of the supply curve equals the slope of the demand curve . When , divergent pivotal innovations increase PS, and when , divergent pivotal innovations decrease PS. Rotating supply with a different intercept creates a different PS curve. The lower the intercept , the higher the PS curve. When there are divergent pivotal shifts in supply, the maximum point of each of these PS curves lies along a curve that bends backward, starts at the origin, and ends at the highest point of the total revenue (TR) curve. When supply is elastic (), TS increases at a constant rate up to where the supply curve is perfectly elastic (), where . On the other hand, when supply is inelastic (), TS increases at a decreasing rate up to where .

Focusing on parallel shifts in supply, graphical simulations reveal that when the supply is elastic (), PS increases at an increasing rate. When the elasticity of supply is unit elastic (), PS has an inflection point. When supply is inelastic (), PS first increases at a decreasing rate, reaches a maximum, and then decreases. When there are parallel shifts of supply, the maximum point on each PS curve lies along a line that begins at the top of the TR curve and ends at the bottom-right corner of the TR curve. So when there are parallel shifts of supply, the maximum PS never lies in the elastic portion of the demand curve. When supply is elastic (), TS increases at an increasing rate up to where the supply is unit elastic (), then increases at a decreasing rate up to where .

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Contributed by: John B. Horowitz, Michael A. Karls, Juan Sesmero, and T. Norman Van Cott (May 2015)
The idea for labeling curves and shading regions is based on code from "Consumer and Producer Surplus" by Fiona Maclachlan.
The idea for selecting curves to display via checkboxes is based on code from "The Backward-Bending Supply Function in Fisheries" by Arne Eide.
Open content licensed under CC BY-NC-SA


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Reference

[1] J. B. Horowitz, M. A. Karls, J. Sesmero, and T. N. Van Cott. "Teaching Students How Continuous Innovation Affects Supply, Producer Surplus, and Consumer Surplus." Ball State University Department of Economics Working Paper Series, ECWP201415, 2015. cms.bsu.edu/academics/collegesanddepartments/mcob/majors-and-degrees/depts/economics/facultyresearch/workingpaperseries.



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