In this video we will examine the concept of producer surplus.
We’ll explore what it means, how we can demonstrate it in simple maths and finally
what it looks like on a graph.
In future videos, we’ll have to remember this concept as we manipulate supply and demand
diagrams but for now we'll focus on the basics
The textbook definition is the difference between what producers are willing to sell
a good or service for and what they actually receive for that good or service.
In this table we willing look at three fictional producers, A, B and C and the price they are
willing to sell a good for, and the price they actually receive and their individual
producer surplus.
Finally, we will total the producer surplus, which is the sum of all the individual producer
surpluses.
Producer A is willing to sell for $2 and actually sells for $5.
Therefore they enjoy a surplus of $3.
Producer B is willing to sell for $3 and actually sells for $5, and enjoys a surplus of $2.
Finally, producer C is willing to sell for $4 and actually receives $5 so they will enjoy
a surplus of $1.
The total producer surplus would be $6 for these three producers.
Next we’ll take a look at a little more complicated example.
When laying out our diagram, it is important to note that price is on the Y-axis and quantity
is on the X-axis.
The demand curve is downward sloping due to consumer behaviour.
The law of demand states that as price falls for a good, quantity demanded will increase.
We label it D.
The supply curve is upward sloping due to seller behaviour.
The law of supply states that as price rises for a good, quantity supplied will increase.
The label for this line is S.
Market equilibrium occurs where supply and demand intersect.
This is where the market ‘clears’.
Hypothetically, this is a point of maximum efficiency, where producer and consumer welfare
are maximized.
We’ll examine the concept of producer welfare OR producer surplus further graphically.
Let’s imagine there are about twelve producers for this product.
Here’s how their producer surplus would look on the graph.
The supply curve slopes upward as at higher prices, producers are willing to supply more
goods and services.
Holding all else constant, higher prices act as an incentive for producers to attain greater
profit.
Consider the supply of bread.
Some people love making bread and would be willing to sell it at a very low price.
If the market price is $10 and I’m willing to sell for $1, then I have a significant
producer surplus.
The next producer would be willing to sell for $2, but receives an $8 surplus.
It’s not as much as mine but it’s still significant.
This trend would continue until the final baker is willing to sell bread for $10 and
it matches the market price - indicating that this baker has no producer surplus.
When drawing or manipulating this diagram, I always insist students follow this approach.
Label all your points with letters so you can easily reference the shape.
The entire area above the supply curve and below the market price is our producer surplus.
In this case the surplus is P*EP1.
I always encourage students to label the area of producer and consumer surplus by letters and not to use shading
because it's very easy for you or the examiner to get confused
when you start shading all different areas.Letters are much clearer so I insist you use this technique.
In a future video we will
manipulate market equilibrium and see how it changes.
For now be able to draw it as such and be comfortable with the concept - before manipulations.
Practice drawing this over and over and it will start to stick.
I’ll include a link for the pdf version of this presentation for your notes.
Feel free to get in touch with any questions in the meantime. Leave a comment below and I’ll be sure to respond!