2.6: Producer Surplus
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Chapter 1 introduced the idea of consumer surplus. If you knew the market demand schedule, you could use it to obtain a monetary value of the benefits in excess of the market price that consumer’s received from participating in a market. Producer surplus is the analogous measure on the supply side of the market. The difference is that producer surplus is calculated from the supply schedule and is the aggregate value of economic profits that producers gain from participating in the market. Graphically, the value of producer surplus in a market can be computed as the area above the inverse supply schedule but below the prevailing market price. In Figure \(\PageIndex{1}\), producer surplus is the triangular area that is shaded in blue. If the supply schedule is linear (as in the supply schedule presented in Figure \(\PageIndex{1}\)), you can use the formula for the area of a triangle to compute producer surplus. When given a value of \(P\), say \(\bar{P}\), you can compute producer surplus as
\(PS = \dfrac{1}{2} \times Q(\bar{P}) \times (\bar{P} - Intercept \: of \: Inverse \: Supply \: Schedule)\)
In Figure \(\PageIndex{1}\), \(\bar(P)_{1}= $35\), the quantity supplied is \(Q(\bar{P}) - 84\), and the intercept of the inverse supply schedule is $14. Given this, producer surplus can be computed as \(\dfrac{1}{2} \times 84 \times 21 = $882\).
In Chapter 1, you learned that consumer surplus is value that the consumer receives over and beyond the price he or she pays for the product. This value is typically not recorded or reported and is often known only to the consumer. Thus, the concept of consumer surplus is a neat way to obtain a measure of consumer welfare. Producer surplus has a similar interpretation. Producer surplus is the value that producers receive from a transaction over and beyond the costs of production. Strictly speaking, producer surplus measures economic profits to the selling side of the market. You might question why there is a need to measure producer surplus because firms generally calculate their profit and report it on financial statements, use it compute taxable income and so forth. The primary value of the producer surplus measure is that it reflects economic profits as opposed to accounting profits. The supply schedule incorporates the opportunity costs of production whereas income statements do not. Later in the course, you will use both consumer and producer surplus to examine the economic performance of markets.