What is Producer Surplus and How is it Measured

What is Producer Surplus

Producer surplus can be described as the difference between what producers are willing and able to supply for a particular good and the price that they actually receive. Producer surplus is generated when the producer is willing to sell their goods at a lower price, and the buyers are willing to accept goods for a higher price. This creates an excess welfare and is identified as an excess demand.

Producer surplus can be graphically represented as follows. The surplus is the area below the market price and above the supply curve. ABO is the producer surplus, and CBO is called the consumer surplus. Both producer surplus and consumer surpluses equal overall economic surplus or the benefit provided by producers and consumers act together in a free market. If a producer has the ability to sell goods at the maximum price or if he can price discriminate perfectly and the consumer is willing to pay that amount for the good, then the producer can capture the entire economic surplus. In other words, producer surplus would be equal to overall economic surplus.What is Producer Surplus and How is it Measured - 1

Changes in Producer Surplus

The amount of producer surplus will increase with the increases in market price and decrease with the decreases in market price when other factors remain unchanged.

Supply curve shifts are directly related with producer surplus. If supply increases, producer surplus will increase and vice versa. As per the following graph, supply has decreased, and equilibrium has shifted from O to O1. At 1st equilibrium, (O) producer receive a large surplus than equilibrium 2 (O1). It can be clearly seen in the highlighted areas.

S>S1

Red color area > O1BC

Hence, Supply and producer surplus have a positive relationship.What is Producer Surplus and How is it Measured - 2

Shifts in the demand curve are directly related to producer surplus. If demand increases, producer surplus increases. If demand decreases, producer surplus decreases. This can be easily understood by the below graph.

D2>D1

O1AB > Highlighted area

Hence Demand and producer surplus also have a positive relationship.What is Producer Surplus and How is it Measured - 3

How to Calculate Producer Surplus

Producer surplus is the excess amount the buyer received. It can be calculated in two ways: using a graph or using an equation.  

Calculating Producer Surplus Using GraphWhat is Producer Surplus and How is it Measured - 4

What is Producer Surplus and How is it Measured - 5

Calculating Producer Surplus Using Equations

A producer is willing to sell 500 toys at $5 each, and consumers are willing to purchase these toys for $7 each. If the producer sells all of the toys to consumers for $7, he receives $3500. To calculate the producer surplus, subtract the amount the producer received by the minimal amount it was willing to accept.

Producer surplus = the actual amount the producer received – minimal amount producer was willing to accept

                            = $7 * 500 – $5 * 500

                            = $3500 – $2500        

                            = $1000

In this case producer surplus is $1000. We can find producer surplus in both ways for any case.

Conclusion

Companies differ greatly in terms of their missions, strategic goals, and product offerings, but every business has the essential goal of making a surplus. The surplus is a concept that describes the amount of utility or value that consumers and producers receive when making transactions. Every producer and consumer in an economy want to gain utility by increasing the surplus.

About the Author: G.Perera


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