<blockquote>
<p>Since a portion of the social surplus generated by investments goes to consumers and not producers individuals in a free market are always under-incentivized to make investments and therefore a degree of investment must be provided by the state, correct?</p>
</blockquote>
<p>No this is not generally correct especially because you are making strong general claims e.g. <em>always</em> and also draw a policy conclusion from is’s, which breaks a principle of Hume's guillotine.</p>
<p>If there are positive externalities, e.g. investment in non-patentable R&amp;D/basic research, then companies won't be able to capture appropriate level of return on investment in such R&amp;D. In this case more socially optimal level of investment can be potentially achieved by some government policy or non-market solution.</p>
<p>However, there are important caveats here;</p>
<ol>
<li><p>Not all investments have externalities. Students often confuse positive/negative externality as any positive or negative effect on other people, but this is simply not true. Following, Mas-Colell Whinston Green (1995)
&quot;Definition &quot;11.B.1 An externality is present whenever the well-being of a consumer or the production possibilities of a firm are directly affected by the actions of another agent in the economy.&quot; .... &quot;When we say 'directly,' we mean to exclude any effects that are mediated by prices.&quot;For example, building a chip factory might have very large positive effects on welfare of workers and even consumers. However, as long as these marginal benefits are reflected in the rate of return on this investment, there are no external effects and level of investment will be optimal, unless some other market failure is present.</p>
</li>
<li><p>It is not apriory clear that the investment has to be provided by the state itself. There are various institutional arrangements other than direct state provision. For example, patents are examples of such institutional arrangement that does not require provision of investment by state. Moreover, this is not necessarily relevant for R&amp;D but can be relevant for other investments such as investments in common pool resources, Nobel Prize winning research of <a href="https://www.nobelprize.org/uploads/2018/06/ostrom_lecture.pdf" rel="nofollow noreferrer">Ostrom</a> shows that it is possible to have non-market but also private solutions for externalities or free rider problems etc.</p>
<p>These solutions usually rely on some community level social enforcement mechanisms, so they are not necessarily applicable to some global scale R&amp;D investments, but they are relevant for investments on local scale.</p>
</li>
<li><p>You are trying to derive oughts from is’s which goes against basic rules of public policy. Public policy is not about making economy as efficient as possible. Goals of public policy depend on particular molar philosophy and what moral philosophy is “the correct one” to follow cannot be derived from positive facts such as what policy mix maximizes GDP per capita.</p>
<p>Depending on moral philosophy you might want to leave some externalities or other economic inefficiencies unaddressed. For example, in Sweden there is a “Pirate” party that has goal to reduce level of IP protection, and they pursue this policy because they believe this is moral thing to do. Yet such policy will lead to under investment in affected IP sectors.</p>
<p>Long story short, you can’t just a priory claim that optimal public policy is policy that maximizes total surplus or total utility etc.</p>
</li>
</ol>
<blockquote>
<p>Another problem is that the older I am the less my money will compound if I invest it reducing the incentive to invest, so I might blow my fortune on frivolities because the reward for investment will either be very small or arrive once I'm dead.</p>
</blockquote>
<p>No this is not problem per se. People do not care just about return for themselves but also for their progeny. In overlapping generations models where people die you do not necessarily get sub-optimal level of investment.</p>
<p>Now to be clear this could lead to problems if you add into a mix some other behavioral issues or market failures. However, in itself aging of an individual and eventual death does not result in under investment.</p>
<p>Moreover,  if the rich person spends the money on frivolous things, then that spending becomes other person’s income. This is macro 101. One person’s spending is another person’s income Y=C+I+G+NX. Then other people will either spend or invest that money.</p>
<p>In fact, during periods of financial crises when the propensity to invest drops, and investment may became for all practical purposes exogenous, such  spending might be even beneficial for raising GDP.</p>
<p>You can see discussion of these Macro issues in any undergraduate macro textbook, for example see Blanchard et al Macroeconomics.</p>
<blockquote>
<p>Another problem is that if I am rich money might become meaningless to me so I stop investing and trying to grow it. Prioritizing my own self-interest in a free market will massively lessen social welfare.</p>
</blockquote>
<p>I do not think this is empirically very realistic. Even extremely rich people have  typically very large marginal propensity to invest l. However, let’s use your behavioral assumption as thought  experiment. This is not a problem per se. It could be problem in combination with some market failures but in well functioning market this is not a problem.</p>
<p>If they spend the money on consumption then it does not matter per se as discussed above.</p>
<p>If they refuse to spend the money at all then that will have to endogenous effect on prices and rate of return. It will be cheaper for other people to buy things, and more desirable for other people to invest.</p>
<p>There can be problems in combination with market imperfections such as price or wage rigidities, but then the root issue is the price rigidity, not “meaninglessness of money” to a rich individual.</p>

CC BY-SA 4.0
2024-07-25T08:54:56.503Z
1. Lets say I had to choose between spending my free time meditating, versus spending my time working and then investing the money I make from work into assets which grow my wealth and then selling all my assets for a profit and then spending the money I have made on my personal consumption. Lets say that both options are equally personally beneficial to me, however, the latter option would produce greater social surplus and yet both options are equally appealing. This demonstrates a market failure wherein pursuing your self-interest in a free market doesn't maximise general welfare.
J.D G
CC BY-SA 4.0
2024-07-25T08:55:07.207Z
2. While the individual could be said to care for his progeny and will thus be incentivised to save it rather than blow it, this market failure would only be resolved assuming that people are 100% benevolent towards their descendants all the time, which is untrue, even if they were, this wouldn't solve the market failure as that might only incentivise them to invest enough for their descendants to live comfortably on a passive income stream, but this degree of investment could be raised to increase broader general welfare and not just the welfare of peoples descendants.
J.D G
CC BY-SA 4.0
2024-07-25T08:55:22.763Z
3. If an individual invests rather than consumes, they still consume, in fact they consume an even greater amount, just at a later date, which means a greater increase in other peoples incomes in the long term, which means that greater social surpluses are produced, between two equally appealing options of either consuming or saving.
J.D G
CC BY-SA 4.0
2024-07-25T08:55:48.477Z
Its good to see you again
J.D G
CC BY-SA 4.0
2024-07-25T09:17:31.717Z
@J.DG re 1: problem is what you are doing is just hand waving. Build a rigorous  model where agent derives utility form leisure/meditation l and some composite good x equally as you postulate so let’s say U= lnx_t + ln l_t subject to inter-temporal budget constraint which allows for investment. It is well known that even in these models there will be optimal level of saving and hence investment as long as you don’t introduce any market failure or behavioral twist like hyperbolic discounting. If you believe otherwise prove it with math. This will force you to show your assumptions explicitly
1muflon1
CC BY-SA 4.0
2024-07-25T09:37:52.143Z
Re 2: people dying is not market failure. Market failure is situation where outcomes are inefficient because of violations of requirements for competitive market. Competitive market does not require immortal people. Moreover, empirically if anything there is evidence for parents, on average, caring for their children too much not too little. One of the best empirical evidence for true altruism there is in the literature is between parents and children. However, any case this is in some sense moot point because again unless you introduce some market failure even if the person is childless
1muflon1
CC BY-SA 4.0
2024-07-25T09:42:18.117Z
And only spends money on consumption 0 investment, economy is endogenous, and lower investment spending by one individual will be offset by higher investment spending by other individuals if there are no market failures that mess up the interest rate or constrain some other people in some way (eg liquidity constraints and so). Hence mortality is not relevant per se you need to add some imperfections and then sure you might get suboptimal investment but not due to mortality. Again if you think that death is sufficient build an endogenous model and prove it otherwise it’s just cheap talk
1muflon1
CC BY-SA 4.0
2024-07-25T09:43:25.837Z
3. It is true that saving and hence investment is postponed consumption. However, the problem is that macroeconomically during times of financial distress investment is exogenous so investing more does not lead to higher income but lower income and also lower overall consumption. This is not how economy normally operates, when economy operates normally you would be correct in saying that it does not matter whether someone invest or spends on consumption but it is not true during times of financial distress. Read in some macro textbook about the paradox of thrift
1muflon1
CC BY-SA 4.0
2024-07-25T10:11:02.723Z
Yes obviously in a real world example a certain degree of investment would be optimal, but in this example the level of investment is just based on what maximizes the agents utility, it doesn't consider the surpluses which would be created for other agents by investing more.
J.D G
CC BY-SA 4.0
2024-07-25T10:13:18.240Z
People dying causes people to become disinterested in investments, which is bad because investments are good for others, this exacerbates the existing market failure of people being underincentivised to invest due to the aforementioned external surpluses it produces unlike other actions
J.D G
CC BY-SA 4.0
2024-07-25T10:16:34.213Z
Why would financial distress mean that the money I spend on investments don't go towards peoples incomes?
J.D G
CC BY-SA 4.0
2024-07-25T10:18:56.117Z
(typing to reach character minimum)
J.D G
CC BY-SA 4.0
2024-07-25T10:49:39.150Z
@J.DG if you believe this is what an average human behaves and it’s not just rare trivial odd behavior, then that problem represents representative agent and you can just multiply the resulting utility of that agent by N to get total welfare. So in that case it would capture the benefit that people get from investment. If you think this is rare behavior then make an endogenous model with heterogenous agents like I suggested in 3. In that case you will get the result I discussed there. Again this is unless you introduce some imperfections. From your text it’s clear you implicitly assume there
1muflon1
CC BY-SA 4.0
2024-07-25T10:50:48.530Z
Are positive externalities but you seem to not to realize it so the best way to realize that fact is not me telling you but you trying to model this in various ways and seeing that to get suboptimal investment you need to make that assumption of externality explicit.
1muflon1
CC BY-SA 4.0
2024-07-25T10:54:46.880Z
Again either there are externalities and then it’s an issue of externality not people dying or there are no externalities and then I would like to see some rigorous proof, because it’s well known that in standard model dying doesn’t result into that. In fact macroeocnomically aging and low birth rates are hypothesized to lead to abnormal level of savings and investment not vice versa, you can read some work of Summers and others on savings glut caused by aging
1muflon1
CC BY-SA 4.0
2024-07-25T11:06:24.317Z
Because during times of financial distress investment becomes exogenous. For simplicity of calculation assume closed economy and no government, so Y= C+I next S=Y-C And as a corollary S = I. If investment is endogenous then higher S means also higher I. If investment is exogenous, which can happen during times of financial distress (e.g. due to Bernanke’s adverse selection model where it becomes impossible to distinguish good and bad borrowers during financial crisis or there are also lot of others proposed explanations for this phenomenon)
1muflon1
CC BY-SA 4.0
2024-07-25T11:06:43.470Z
Let us [continue this discussion in chat](https://chat.stackexchange.com/rooms/154290/discussion-between-j-d-g-and-1muflon1).
J.D G
CC BY-SA 4.0
2024-07-25T11:07:20.967Z
this relationship breaks because any potential increase in S is offset by drop of Y and aggregate investment or saving does not change. In such situation one person saving is just other person’s lost income without any new net investment
1muflon1
CC BY-SA 4.0
2024-07-23T13:24:53.877Z
2024-07-23T13:30:14.377Z
2024-07-23T13:30:14.377Z
1muflon1
<p>Existence of consumer surplus does not mean that producer does not capture some benefits of investment.</p>
<p>When we talk about positive externalities (which seems like where you got that idea), we do not talk about benefits in terms of producer or consumer surplus. We talk about marginal private (MPB) and social benefit (MSB).</p>
<p>Externalities exist when marginal private benefit are not equal to marginal social benefit (MPB <span class="math-container">$\neq$</span> MSB), these are called consumption externalities, more specifically <span class="math-container">$MPB&lt;MSB$</span> implies positive consumption externality and <span class="math-container">$MPB&gt;MSB$</span> negative consumption externality,  or production externalities when marginal private costs are not equal to marginal social cost (<span class="math-container">$MSC \neq MPC$</span>), and analogously there can be positive or negative production externalities.</p>
<p>Marginal social benefit is the demand  curve in contra-factual world where the externality does not exist. Only when this hypothetical demand curve is not equal to regular demand curve is when you can say that producers do not capture some of the benefits. Marginal social costs is the supply function in the hypothetical contra factual without any externality. As in the case with demand externality you can only claim that producers do not capture some benefit if there is difference between this two (in this case when MSC&lt;MPC).</p>
<p>Consumer surplus can exist both with or without externalities. Consumer surplus is not the benefit we talk about when we talk that producers do not capture benefits of production. Consumer surplus is the area under demand curve and above price. External benefit is the vertical distance between hypothetical demand curve without externalities and actual demand curve (or supply curve when we talk about supply side externalities).</p>
<p>You get inefficient production and investment decisions when the supply or demand curve do not overlap MSB or MSC curve. However, this has little to do with consumer surplus. As long as demand and supply curve are 'correct' in the sense both demand and supply are based on marginal social benefits and costs respectively, then size of consumer surplus is irrelevant.</p>

CC BY-SA 4.0
2024-07-26T00:34:10.630Z
Perhaps calling this an 'externality' in the traditional sense of the term is incorrect, but if I were to invest in IP and then sold access to that IP the fact that I am generating a consumer surplus for others would necessarily be positive consequence of my decision to invest which is not being internalized by me, correct?
J.D G
CC BY-SA 4.0
2024-07-26T12:36:33.310Z
@J.DG no that is incorrect as my answer explains. I will try to explain it more succinctly because perhaps longer answer is too much for you to understand. For decisions to be optimal socially and privately they have to satisfy MSB=MSC and MPB=MPC respectively. MSB and MPB are the benefits individuals have to be compensated for to behave optimally. Any other benefits aside MSB and MPB are irrelevant for optimal decision making. English is context based language as opposed to languages like German, maybe you are native speaker in such language and that's why you have problem understanding this.
Leeh Mizrahi
CC BY-SA 4.0
2024-07-26T12:37:36.643Z
In English we just say benefits, but we mean MSB and MPB other benefits like surplus are irrelevant. Optimal decisions can be elicited from consumers even if they get 0 surplus and producers get lot of surplus, and other way around optimal producer decisions can be elicited when producers get 0 surplus and consumers get all the surplus. What matters is MSB=MSC and MPB=MPC.
Leeh Mizrahi
CC BY-SA 4.0
2024-07-29T02:39:23.710Z
Right but when I make an investment the marginal social benefit of this decision exceeds the marginal private benefit, so when MPB intersects MPC I stop investing, but MSB still exceeds MSC since Marginal Social Costs in this instance equal Marginal Private Costs, leading to underinvestment. This is because when I make an investment the generated surpluses flow to both consumers and producers, and not just producers. By 'surplus' I mean when a unit is produced whose sale price exceeds the cost of its production generating profit for the producer, and when the consumers WTP exceeds the price,
J.D G
CC BY-SA 4.0
2024-07-29T02:41:40.183Z
creating a consumer surplus for the consumer . The existence of this underinvestment can be intuitively demonstrated by the fact that an individual might feel equally attracted to the options of investing his income versus consuming it,  but since investing it would produce more non-internalized benefits for others this option is clearly underchosen meaning underinvestment.
J.D G
CC BY-SA 4.0
2024-07-30T23:41:36.150Z
@J.DG no that is not correct, please read my previous comments and answer
Leeh Mizrahi
CC BY-SA 4.0
2024-07-31T05:38:39.043Z
How is it incorrect?
J.D G
CC BY-SA 4.0
2024-07-25T16:57:59.310Z
2024-07-25T18:32:42.637Z
2024-07-25T18:32:42.637Z
Leeh Mizrahi
<p>Since a portion of the social surplus generated by investments goes to consumers and not producers individuals in a free market are always under-incentivized to make investments and therefore a degree of investment must be provided by the state, correct?</p>
<p>Another problem is that the older I am the less my money will compound if I invest it reducing the incentive to invest, so I might blow my fortune on frivolities because the reward for investment will either be very small or arrive once I'm dead. Another problem is that if I am rich money might become meaningless to me so I stop investing and trying to grow it. Prioritizing my own self-interest in a free market will massively lessen social welfare.</p>

CC BY-SA 4.0
2024-07-23T11:48:37.820Z
For some investments, it can be argued that there is a positive externality. Some of these positive externalities benefit the society at large.  It is also correct that underinvestment can result from free-market provision when there are positive externalities. However, It is incorrect to claim that this holds for all investments in general. Assuming it is true, economists see it as a market failure and one alternative would be some sort of state involvement but not necessarily state-provision. I think education is a good example.
Jesper Hybel
CC BY-SA 4.0
2024-07-25T09:01:09.770Z
But if the benefit (the TOTAL social surplus) of my action (investment) exceeds beyond the compensation I receive (my producer profits) isn't that a textbook case of the private benefit being beneath the social benefit, and therefore my investment is undercompensated in a free market. I mean you cant say that all the benefits to society of Bill Gates founding Microsoft have been recouped by him. The compensation he receives is necessarily less than the value he creates as I know for fact I attained consumer surpluses from his products.
J.D G
CC BY-SA 4.0
2024-07-25T09:19:06.320Z
How is this in any way inconsistent with anything I said? You claim in the pos this is 'always' the case. You cannot logically argue always by example.  You are sidetracking - this is a question-answer forum, not a debate club.
Jesper Hybel
CC BY-SA 4.0
2024-07-26T00:40:09.770Z
Yes but I don't understand how your answer is the correct one. It is always true that some consumer surplus is generated by an investment, in which case some benefit arises from an investment which isn't internalized by the producer, which would be like an externality. If I make IP and sell access to it, I only get the portion of the social surplus which goes to the producer, but the consumer surplus, which was also generated by my investment, goes to other people. So its conceivable that there are cases where people who would've invested if they also got the consumer surplus don't
J.D G
CC BY-SA 4.0
2024-07-26T00:40:19.017Z
due to insufficient profits
J.D G
CC BY-SA 4.0
2024-07-26T01:21:29.657Z
No. You partially misunderstand the concept of consumer surplus. It is true that when you sell something on a market consumers get a consumer surplus. This is part of the benefit generated by having the markets. It is not like an externality because an externality is about someone, not part of the market being affected. The fact that firms do not consider the consumer surplus does not lead to underinvestment. .... It is not always the case that there is a consumer surplus. A monopoly with perfect price discrimination is a case without consumer surplus.
Jesper Hybel
CC BY-SA 4.0
2024-07-26T01:25:37.943Z
That's true. But in a non-perfectly-price discriminating, imperfectly competitive market there is a consumer surplus, there is a benefit from the investment which isn't internalized by the investor and therefore there is the possibility of a situation arising where the private cost of making the investment outweighs the private benefit, despite the social benefit outweighing the private cost, correct?
J.D G
CC BY-SA 4.0
2024-07-26T01:39:15.013Z
On the market there is producer surplus and consumer surplus - both are private benefits. If the market is perfectly competitive and there are NO market failures like the presence of externalities, then the firm can't do better (even if deviating from maximizing profits). The investment strategy chosen by the firm is chosen by the firm to optimize profit, but the beauty of the perfectly competitive market is that this maximizes the sum of consumer and producer surplus which is the total social benefit. So I would say, no that is not correct.
Jesper Hybel
CC BY-SA 4.0
2024-07-26T01:47:19.997Z
But what if we are dealing with an imperfectly competitive market. I am deciding whether to spend money developing an IP and then selling access to it. I look at the revenue I will make from it, which is a mere portion of the total social surplus which the investment will generate and decide it is insufficient to cover the cost of the making the IP, despite the fact that the total social, surplus that is generated outweigh the costs. Wouldn't this mean that underinvestment has occurred?
J.D G
CC BY-SA 4.0
2024-07-26T02:03:40.210Z
No. In perfect competition market equilibrium, it is not possible. You have already invested optimally. Any further investment will generate extra revenue outweighed by the cost resulting in negative profits. You are selling more so the price is lower hence consumers are more happy. But you are also selling at lower prices so part of what was producer surplus before - at the higher prices - is now consumer surplus. You are only making the consumers better of by making producers worse of.
Jesper Hybel
CC BY-SA 4.0
2024-07-29T02:31:58.660Z
Right but the benefit to the consumers is greater than the loss to the producers so it'd be socially optimal if you did increase investment. Since not all of the social benefit created by an investment is internalized by the producer, leading to underinvestment unless the investor wasn't focused on private gain (the government) or if the investor was rewarded by some sort of government compensation.
J.D G
CC BY-SA 4.0
2024-07-29T11:52:44.437Z
No. In perfect competition market equilibrium, it is not possible. If you still your description of reality is right there are - as I see it - only two possibilities: (1) it is not a case of perfect competition for example there is some market failure where externalities are one option (2) you are simply using the words 'consumer surplus' and 'social benefit' in another way than economists are .... In the first case, you have already received an answer from @Muflon and in the latter case this question does not belong on stack economics because while seeming to be about economics it is not.
Jesper Hybel
CC BY-SA 4.0
2024-07-30T03:49:00.703Z
I'm not talking about a situation of perfect competition. I am talking about the economic reality we are in right now, where all the benefits of making investments aren't internalized by producers due to the consumer surplus which these investments generate, thereby under-incentivizing making these investments.
J.D G
CC BY-SA 4.0
2024-07-30T05:09:39.403Z
Ok (2) it is then.
Jesper Hybel
CC BY-SA 4.0
2024-07-31T05:42:45.540Z
How does it have nothing to do with economics?
J.D G
<microeconomics><financial-economics><investment><capitalism>
Are individuals under-incentivized to make investments as they aren't able to net all the social surplus they generate?
J.D G
# Are individuals under-incentivized to make investments as they aren't able to net all the social surplus they generate?

(Asked by: username_0 on 2024-07-23)

Since a portion of the social surplus generated by investments goes to consumers and not producers individuals in a free market are always under-incentivized to make investments and therefore a degree of investment must be provided by the state, correct?

Another problem is that the older I am the less my money will compound if I invest it reducing the incentive to invest, so I might blow my fortune on frivolities because the reward for investment will either be very small or arrive once I'm dead. Another problem is that if I am rich money might become meaningless to me so I stop investing and trying to grow it. Prioritizing my own self-interest in a free market will massively lessen social welfare.

**Tags:** microeconomics, financial-economics, investment, capitalism

> **Comments:**
> **username_1**: For some investments, it can be argued that there is a positive externality. Some of these positive externalities benefit the society at large.  It is also correct that underinvestment can result from free-market provision when there are positive externalities. However, It is incorrect to claim that this holds for all investments in general. Assuming it is true, economists see it as a market failure and one alternative would be some sort of state involvement but not necessarily state-provision. I think education is a good example.  
> **username_0**: But if the benefit (the TOTAL social surplus) of my action (investment) exceeds beyond the compensation I receive (my producer profits) isn't that a textbook case of the private benefit being beneath the social benefit, and therefore my investment is undercompensated in a free market. I mean you cant say that all the benefits to society of Bill Gates founding Microsoft have been recouped by him. The compensation he receives is necessarily less than the value he creates as I know for fact I attained consumer surpluses from his products.  
> **username_1**: How is this in any way inconsistent with anything I said? You claim in the pos this is 'always' the case. You cannot logically argue always by example.  You are sidetracking - this is a question-answer forum, not a debate club.  
> **username_0**: Yes but I don't understand how your answer is the correct one. It is always true that some consumer surplus is generated by an investment, in which case some benefit arises from an investment which isn't internalized by the producer, which would be like an externality. If I make IP and sell access to it, I only get the portion of the social surplus which goes to the producer, but the consumer surplus, which was also generated by my investment, goes to other people. So its conceivable that there are cases where people who would've invested if they also got the consumer surplus don't  
> **username_0**: due to insufficient profits  
> **username_1**: No. You partially misunderstand the concept of consumer surplus. It is true that when you sell something on a market consumers get a consumer surplus. This is part of the benefit generated by having the markets. It is not like an externality because an externality is about someone, not part of the market being affected. The fact that firms do not consider the consumer surplus does not lead to underinvestment. .... It is not always the case that there is a consumer surplus. A monopoly with perfect price discrimination is a case without consumer surplus.  
> **username_0**: That's true. But in a non-perfectly-price discriminating, imperfectly competitive market there is a consumer surplus, there is a benefit from the investment which isn't internalized by the investor and therefore there is the possibility of a situation arising where the private cost of making the investment outweighs the private benefit, despite the social benefit outweighing the private cost, correct?  
> **username_1**: On the market there is producer surplus and consumer surplus - both are private benefits. If the market is perfectly competitive and there are NO market failures like the presence of externalities, then the firm can't do better (even if deviating from maximizing profits). The investment strategy chosen by the firm is chosen by the firm to optimize profit, but the beauty of the perfectly competitive market is that this maximizes the sum of consumer and producer surplus which is the total social benefit. So I would say, no that is not correct.  
> **username_0**: But what if we are dealing with an imperfectly competitive market. I am deciding whether to spend money developing an IP and then selling access to it. I look at the revenue I will make from it, which is a mere portion of the total social surplus which the investment will generate and decide it is insufficient to cover the cost of the making the IP, despite the fact that the total social, surplus that is generated outweigh the costs. Wouldn't this mean that underinvestment has occurred?  
> **username_1**: No. In perfect competition market equilibrium, it is not possible. You have already invested optimally. Any further investment will generate extra revenue outweighed by the cost resulting in negative profits. You are selling more so the price is lower hence consumers are more happy. But you are also selling at lower prices so part of what was producer surplus before - at the higher prices - is now consumer surplus. You are only making the consumers better of by making producers worse of.  
> **username_0**: Right but the benefit to the consumers is greater than the loss to the producers so it'd be socially optimal if you did increase investment. Since not all of the social benefit created by an investment is internalized by the producer, leading to underinvestment unless the investor wasn't focused on private gain (the government) or if the investor was rewarded by some sort of government compensation.  
> **username_1**: No. In perfect competition market equilibrium, it is not possible. If you still your description of reality is right there are - as I see it - only two possibilities: (1) it is not a case of perfect competition for example there is some market failure where externalities are one option (2) you are simply using the words 'consumer surplus' and 'social benefit' in another way than economists are .... In the first case, you have already received an answer from @Muflon and in the latter case this question does not belong on stack economics because while seeming to be about economics it is not.  
> **username_0**: I'm not talking about a situation of perfect competition. I am talking about the economic reality we are in right now, where all the benefits of making investments aren't internalized by producers due to the consumer surplus which these investments generate, thereby under-incentivizing making these investments.  
> **username_1**: Ok (2) it is then.  
> **username_0**: How does it have nothing to do with economics?  

---

## 2 answers

### Answer by username_2 on 2024-07-23. Score: 3

> Since a portion of the social surplus generated by investments goes to consumers and not producers individuals in a free market are always under-incentivized to make investments and therefore a degree of investment must be provided by the state, correct?

No this is not generally correct especially because you are making strong general claims e.g. *always* and also draw a policy conclusion from is’s, which breaks a principle of Hume's guillotine.

If there are positive externalities, e.g. investment in non-patentable R&D/basic research, then companies won't be able to capture appropriate level of return on investment in such R&D. In this case more socially optimal level of investment can be potentially achieved by some government policy or non-market solution.

However, there are important caveats here;

1. Not all investments have externalities. Students often confuse positive/negative externality as any positive or negative effect on other people, but this is simply not true. Following, Mas-Colell Whinston Green (1995)
   "Definition "11.B.1 An externality is present whenever the well-being of a consumer or the production possibilities of a firm are directly affected by the actions of another agent in the economy." .... "When we say 'directly,' we mean to exclude any effects that are mediated by prices."For example, building a chip factory might have very large positive effects on welfare of workers and even consumers. However, as long as these marginal benefits are reflected in the rate of return on this investment, there are no external effects and level of investment will be optimal, unless some other market failure is present.
2. It is not apriory clear that the investment has to be provided by the state itself. There are various institutional arrangements other than direct state provision. For example, patents are examples of such institutional arrangement that does not require provision of investment by state. Moreover, this is not necessarily relevant for R&D but can be relevant for other investments such as investments in common pool resources, Nobel Prize winning research of [Ostrom](https://www.nobelprize.org/uploads/2018/06/ostrom_lecture.pdf) shows that it is possible to have non-market but also private solutions for externalities or free rider problems etc.

   These solutions usually rely on some community level social enforcement mechanisms, so they are not necessarily applicable to some global scale R&D investments, but they are relevant for investments on local scale.
3. You are trying to derive oughts from is’s which goes against basic rules of public policy. Public policy is not about making economy as efficient as possible. Goals of public policy depend on particular molar philosophy and what moral philosophy is “the correct one” to follow cannot be derived from positive facts such as what policy mix maximizes GDP per capita.

   Depending on moral philosophy you might want to leave some externalities or other economic inefficiencies unaddressed. For example, in Sweden there is a “Pirate” party that has goal to reduce level of IP protection, and they pursue this policy because they believe this is moral thing to do. Yet such policy will lead to under investment in affected IP sectors.

   Long story short, you can’t just a priory claim that optimal public policy is policy that maximizes total surplus or total utility etc.

> Another problem is that the older I am the less my money will compound if I invest it reducing the incentive to invest, so I might blow my fortune on frivolities because the reward for investment will either be very small or arrive once I'm dead.

No this is not problem per se. People do not care just about return for themselves but also for their progeny. In overlapping generations models where people die you do not necessarily get sub-optimal level of investment.

Now to be clear this could lead to problems if you add into a mix some other behavioral issues or market failures. However, in itself aging of an individual and eventual death does not result in under investment.

Moreover, if the rich person spends the money on frivolous things, then that spending becomes other person’s income. This is macro 101. One person’s spending is another person’s income Y=C+I+G+NX. Then other people will either spend or invest that money.

In fact, during periods of financial crises when the propensity to invest drops, and investment may became for all practical purposes exogenous, such spending might be even beneficial for raising GDP.

You can see discussion of these Macro issues in any undergraduate macro textbook, for example see Blanchard et al Macroeconomics.

> Another problem is that if I am rich money might become meaningless to me so I stop investing and trying to grow it. Prioritizing my own self-interest in a free market will massively lessen social welfare.

I do not think this is empirically very realistic. Even extremely rich people have typically very large marginal propensity to invest l. However, let’s use your behavioral assumption as thought experiment. This is not a problem per se. It could be problem in combination with some market failures but in well functioning market this is not a problem.

If they spend the money on consumption then it does not matter per se as discussed above.

If they refuse to spend the money at all then that will have to endogenous effect on prices and rate of return. It will be cheaper for other people to buy things, and more desirable for other people to invest.

There can be problems in combination with market imperfections such as price or wage rigidities, but then the root issue is the price rigidity, not “meaninglessness of money” to a rich individual.

> **Comments:**
> **username_0**: 1. Lets say I had to choose between spending my free time meditating, versus spending my time working and then investing the money I make from work into assets which grow my wealth and then selling all my assets for a profit and then spending the money I have made on my personal consumption. Lets say that both options are equally personally beneficial to me, however, the latter option would produce greater social surplus and yet both options are equally appealing. This demonstrates a market failure wherein pursuing your self-interest in a free market doesn't maximise general welfare.  
> **username_0**: 2. While the individual could be said to care for his progeny and will thus be incentivised to save it rather than blow it, this market failure would only be resolved assuming that people are 100% benevolent towards their descendants all the time, which is untrue, even if they were, this wouldn't solve the market failure as that might only incentivise them to invest enough for their descendants to live comfortably on a passive income stream, but this degree of investment could be raised to increase broader general welfare and not just the welfare of peoples descendants.  
> **username_0**: 3. If an individual invests rather than consumes, they still consume, in fact they consume an even greater amount, just at a later date, which means a greater increase in other peoples incomes in the long term, which means that greater social surpluses are produced, between two equally appealing options of either consuming or saving.  
> **username_0**: Its good to see you again  
> **username_2**: @J.DG re 1: problem is what you are doing is just hand waving. Build a rigorous  model where agent derives utility form leisure/meditation l and some composite good x equally as you postulate so let’s say U= lnx_t + ln l_t subject to inter-temporal budget constraint which allows for investment. It is well known that even in these models there will be optimal level of saving and hence investment as long as you don’t introduce any market failure or behavioral twist like hyperbolic discounting. If you believe otherwise prove it with math. This will force you to show your assumptions explicitly  
> **username_2**: Re 2: people dying is not market failure. Market failure is situation where outcomes are inefficient because of violations of requirements for competitive market. Competitive market does not require immortal people. Moreover, empirically if anything there is evidence for parents, on average, caring for their children too much not too little. One of the best empirical evidence for true altruism there is in the literature is between parents and children. However, any case this is in some sense moot point because again unless you introduce some market failure even if the person is childless  
> **username_2**: And only spends money on consumption 0 investment, economy is endogenous, and lower investment spending by one individual will be offset by higher investment spending by other individuals if there are no market failures that mess up the interest rate or constrain some other people in some way (eg liquidity constraints and so). Hence mortality is not relevant per se you need to add some imperfections and then sure you might get suboptimal investment but not due to mortality. Again if you think that death is sufficient build an endogenous model and prove it otherwise it’s just cheap talk  
> **username_2**: 3. It is true that saving and hence investment is postponed consumption. However, the problem is that macroeconomically during times of financial distress investment is exogenous so investing more does not lead to higher income but lower income and also lower overall consumption. This is not how economy normally operates, when economy operates normally you would be correct in saying that it does not matter whether someone invest or spends on consumption but it is not true during times of financial distress. Read in some macro textbook about the paradox of thrift  
> **username_0**: Yes obviously in a real world example a certain degree of investment would be optimal, but in this example the level of investment is just based on what maximizes the agents utility, it doesn't consider the surpluses which would be created for other agents by investing more.  
> **username_0**: People dying causes people to become disinterested in investments, which is bad because investments are good for others, this exacerbates the existing market failure of people being underincentivised to invest due to the aforementioned external surpluses it produces unlike other actions  
> **username_0**: Why would financial distress mean that the money I spend on investments don't go towards peoples incomes?  
> **username_0**: (typing to reach character minimum)  
> **username_2**: @J.DG if you believe this is what an average human behaves and it’s not just rare trivial odd behavior, then that problem represents representative agent and you can just multiply the resulting utility of that agent by N to get total welfare. So in that case it would capture the benefit that people get from investment. If you think this is rare behavior then make an endogenous model with heterogenous agents like I suggested in 3. In that case you will get the result I discussed there. Again this is unless you introduce some imperfections. From your text it’s clear you implicitly assume there  
> **username_2**: Are positive externalities but you seem to not to realize it so the best way to realize that fact is not me telling you but you trying to model this in various ways and seeing that to get suboptimal investment you need to make that assumption of externality explicit.  
> **username_2**: Again either there are externalities and then it’s an issue of externality not people dying or there are no externalities and then I would like to see some rigorous proof, because it’s well known that in standard model dying doesn’t result into that. In fact macroeocnomically aging and low birth rates are hypothesized to lead to abnormal level of savings and investment not vice versa, you can read some work of Summers and others on savings glut caused by aging  
> **username_2**: Because during times of financial distress investment becomes exogenous. For simplicity of calculation assume closed economy and no government, so Y= C+I next S=Y-C And as a corollary S = I. If investment is endogenous then higher S means also higher I. If investment is exogenous, which can happen during times of financial distress (e.g. due to Bernanke’s adverse selection model where it becomes impossible to distinguish good and bad borrowers during financial crisis or there are also lot of others proposed explanations for this phenomenon)  
> **username_0**: Let us [continue this discussion in chat](https://chat.stackexchange.com/rooms/154290/discussion-between-j-d-g-and-username_2).  
> **username_2**: this relationship breaks because any potential increase in S is offset by drop of Y and aggregate investment or saving does not change. In such situation one person saving is just other person’s lost income without any new net investment  

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### Answer by username_3 on 2024-07-25. Score: 1

Existence of consumer surplus does not mean that producer does not capture some benefits of investment.

When we talk about positive externalities (which seems like where you got that idea), we do not talk about benefits in terms of producer or consumer surplus. We talk about marginal private (MPB) and social benefit (MSB).

Externalities exist when marginal private benefit are not equal to marginal social benefit (MPB $\neq$ MSB), these are called consumption externalities, more specifically $MPB implies positive consumption externality and $MPB>MSB$ negative consumption externality, or production externalities when marginal private costs are not equal to marginal social cost ($MSC \neq MPC$), and analogously there can be positive or negative production externalities.

Marginal social benefit is the demand curve in contra-factual world where the externality does not exist. Only when this hypothetical demand curve is not equal to regular demand curve is when you can say that producers do not capture some of the benefits. Marginal social costs is the supply function in the hypothetical contra factual without any externality. As in the case with demand externality you can only claim that producers do not capture some benefit if there is difference between this two (in this case when MSC

Consumer surplus can exist both with or without externalities. Consumer surplus is not the benefit we talk about when we talk that producers do not capture benefits of production. Consumer surplus is the area under demand curve and above price. External benefit is the vertical distance between hypothetical demand curve without externalities and actual demand curve (or supply curve when we talk about supply side externalities).

You get inefficient production and investment decisions when the supply or demand curve do not overlap MSB or MSC curve. However, this has little to do with consumer surplus. As long as demand and supply curve are 'correct' in the sense both demand and supply are based on marginal social benefits and costs respectively, then size of consumer surplus is irrelevant.

> **Comments:**
> **username_0**: Perhaps calling this an 'externality' in the traditional sense of the term is incorrect, but if I were to invest in IP and then sold access to that IP the fact that I am generating a consumer surplus for others would necessarily be positive consequence of my decision to invest which is not being internalized by me, correct?  
> **username_3**: @J.DG no that is incorrect as my answer explains. I will try to explain it more succinctly because perhaps longer answer is too much for you to understand. For decisions to be optimal socially and privately they have to satisfy MSB=MSC and MPB=MPC respectively. MSB and MPB are the benefits individuals have to be compensated for to behave optimally. Any other benefits aside MSB and MPB are irrelevant for optimal decision making. English is context based language as opposed to languages like German, maybe you are native speaker in such language and that's why you have problem understanding this.  
> **username_3**: In English we just say benefits, but we mean MSB and MPB other benefits like surplus are irrelevant. Optimal decisions can be elicited from consumers even if they get 0 surplus and producers get lot of surplus, and other way around optimal producer decisions can be elicited when producers get 0 surplus and consumers get all the surplus. What matters is MSB=MSC and MPB=MPC.  
> **username_0**: Right but when I make an investment the marginal social benefit of this decision exceeds the marginal private benefit, so when MPB intersects MPC I stop investing, but MSB still exceeds MSC since Marginal Social Costs in this instance equal Marginal Private Costs, leading to underinvestment. This is because when I make an investment the generated surpluses flow to both consumers and producers, and not just producers. By 'surplus' I mean when a unit is produced whose sale price exceeds the cost of its production generating profit for the producer, and when the consumers WTP exceeds the price,  
> **username_0**: creating a consumer surplus for the consumer . The existence of this underinvestment can be intuitively demonstrated by the fact that an individual might feel equally attracted to the options of investing his income versus consuming it,  but since investing it would produce more non-internalized benefits for others this option is clearly underchosen meaning underinvestment.  
> **username_3**: @J.DG no that is not correct, please read my previous comments and answer  
> **username_0**: How is it incorrect?  

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