Producer Surplus

© 1999-2020, Douglas A.Ruby (06-04-2020)

Like the concept of Consumer Surplus, Sellers or business firms also have an incetive to participate in the market. This comes in the form of Producer Surplus (PS) which is measured as the difference between the market price received for selling each unit of a good or service over-and-above the Variable Costs of production.

PSunit = Pmkt - per-unit (Variable) Costs

We have noted that the firm's supply curve is derived from that firm's Marginal Cost curve above Average Variable Costs. Given the following simple cost equations:

Total Costs = Fixed Costs + Variable Costs
TC = FC + b(Q) -- 'b' represents per-unit (average) variable costs.
MC = dTC / dQ = b

The Marginal cost for each unit produced is equal to the per-unit cost. As we sum over all units supplied, we find that the area below the firm's supply curve is equal to the Variable costs of production. For the firm selling at a market-determined price 'P0 and selling Q0 units, Total Revenue is equal to P0 x Q0. Variable Costs, as stated is the area below the supply curve. The difference represents Producer Surplus -- value that contributes to the firm's Fixed Costs and to (normal) Profits.

This difference is the reward to the business firm for participating in the market.

Figure 1, Producer Surplus
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Anything that causes market price to increase, will increase Total Revenue by a greater amount than the variable costs of production. Producer Surplus increases -- a measure of the benefit or increase welfare accruing to the supply-side of the market.

Concepts for Review:
Top of page related: Consumer Surplus previous: The Costs of Production (short run) next: Taxes and Surplus Changes Microeconomic Theory
© 1999-2020, Douglas A.Ruby (05-21-2020)