Producer and consumer surplus are key concepts used in the evaluation of markets and changes in market conditions.

Whenever markets establish a price economists can assess the benefit to consumers and producers of that particular price. The benefit to consumers and producers can be assessed by considering the 'surplus' gained during a transaction.

From the consumer's point of view this surplus can be considered in terms of 'utility' and from the producer's perspective the benefit can be expressed in terms of 'profits'. Above a certain point, utility and profits are considered to be a 'surplus'.

Producer surplus

Producer surplus is the additional benefit derived by producers when the price they receive is more than the minimum they are prepared to receive.

If we assume that a producer wishes at the very least to cover their opportunity cost (so that they carry on in business) then any reward above this is the producer's surplus - it is equivalent to the idea of super-normal profits used in the 'theory of the firm'.

A supply curve reflects the expected marginal costs incurred by producers when supplying goods and services.

Covering the marginal cost of production is essential for firms. If the firm produces Q1 units, the marginal cost is at ‘m’. However, if the market price is P, producer surplus of ‘m’ to ‘x’ is gained.

Producer surplus

Graphically, producer surplus is the area from the supply curve to the price line. Producer surplus is gained whenever revenue exceeds the minimum necessary to cover marginal cost. The higher the price, the greater the area of producer surplus.

Video on producer surplus

Changes in producer surplus

With a price increase (following an increase in demand) the area for producer surplus will also increase, from area P,B,E to area P1,C,E - an increase of area P1,B,C,P.

Producer surplus
facebook link logo twitter link logo email link logo whatsapp link logo gmail link logo google classroom link logo