Producer surplus - What is a producer surplus?
Producer surplus is the difference between the amount that a seller would be willing to accept for their products/services versus what those products/services are actually worth on the market.
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The producer surplus appears when the price that a seller would get for their goods at market value is higher than the minimum that they would be willing to accept for them. This surplus occurs based on the price that they incur to produce the product.
The producer surplus occurs between the seller’s supply curve and the market price. When viewed on a graph, the producer surplus area falls above the supply curve and below the market price line. The supply curve is the marginal cost curve for a business.
Producer surplus can be viewed as an equation:
Total revenue - total cost = producer surplus
When plugging in the numbers, total revenue is the amount that a business receives from selling a certain number of a product, while the total cost is the amount that the business incurred in producing that amount of product.
Producer surplus can change due to market prices as the supply and demand change. As you can likely surmise from the graph above, if the market price were to increase, the producer surplus would follow suit. It would also decrease in the case that the market price decreased.
The producer surplus is also closely linked with consumer surplus. The combination of the two provides the economic surplus, which shows the benefits of sellers and buyers completing transactions in a free market.
When a business has a producer surplus, they’re selling their product/service at a price that covers their costs of production.
When a business creates a product, the first units of that product are the cheapest to produce. As the business continues to create more, the additional amounts of the product become more expensive to produce.
The producer surplus allows a business to understand the benefit of a particular product, and understand how it contributes to their economic welfare. It can also help to determine an effective pricing strategy.