PRODUCER SURPLUS

1
PRODUCER SURPLUS

• PRINCIPLES OF MICROECONOMICS

Dr. Fidel Gonzalez Department of Economics and
Intl. Business Sam Houston State University
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OPPORTUNITY COST
MARGINAL ANALYSIS
Elasticity
Elasticity
SUPPLY
DEMAND
MARKET EQUILIBRIUM
CONSUMER SURPLUS, PRODUCER SURPLUS AND TOTAL
SURPLUS
MARKET EFFICIENCY
MARKET FAILURE
Pigouvian Taxes Quotas Coase Theorem Command and
control
EXTERNALITIES
TAXES
PUBLIC GOODS
COMMON GOODS
ARTIFICIALLY SCARCE GOODS
GAME THEORY
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Remember the example about grading test. In that
example, I show you how to derive the supply
using the marginal cost .
One assignment
I am the only grader
Cost 3

Cost 8
Two assignments
Two graders
3

8
5
Three assignments



Four graders


3
5
18
5
5

Cost 18
Seven graders



Four assignments



3
5
5
5


5
Cost 33


33
5

5

4
Review producer surplus
Now, I can get the total cost of grading one,
two, three and four assignments
I will be willing to grade as long as what I get
paid is equal to my total cost.
I am willing to grade one assignment for at least
3 because that will cover my opportunity cost.
3
I am willing to grade two assignments for at
least 8 because that covers my opportunity cost
and the payment to my assistant of 5.
8
I am willing to grade three assignments for at
least 18 because that covers my opportunity
cost and the payment to my three assistants of 5
each. My cost is 15 for the three assistants
plus 3 for my opportunity cost, that is 18
total.
18
I am willing to grade four assignments for at
least 33 because that covers my opportunity
cost and the payment to my six assistants of 5
each. My cost is 30 for the six assistants plus
3 for my opportunity cost, that is 33 total.
33
5
Review producer surplus
The cost of grading the first, second, third and
fourth assignment, is the increase in the total
cost for an extra assignment graded, this is
called Marginal Cost.
Marginal Cost change in the cost to produce an
extra unit.
To grade the first assignment I must receive at
least 3.
3
If I am willing to grade the first assignment for
3 and grade two assignments for 8, then it must
be that I am willing to grade the second
assignment for 5, because my cost increase by 5.
3
5
8


If I am willing to grade the first assignment for
3, the second for 5 and grade three assignments
for 18, then it must be that I am willing to
grade the third assignment for 10, because my
cost increased by 10.
3
10
18



5
If I am willing to grade the first assignment for
3, the second for 5, the third for 10 and
grade four assignments for 33, then it must be
that I am willing to grade the third assignment
for 15, because my cost increased by 15.
3




5
10
15
33
6
Review producer surplus
The information from the previous slides is now
presented in a table
Below the table you can see the graph of the
marginal willingness to produce for the first,
second, third and fourth assignment.

The marginal cost to grade the first assignment
is 3
15
10
The marginal cost to grade for the second
assignment is 5
5
The marginal cost to grade the third assignment
is 10
3
The marginal cost to grade the fourth assignment
is 15
assignments
4
3
2
1
7
Review producer surplus
Assume that SHSU pays me 16 for each assignment
graded.
Lets obtain the producer surplus for each
assignment.
Producer Surplus revenue received from the sale
minus the willingness to produce the good.
I am willing to grade the first assignment for 3
but I receive 16
The Producer Surplus for the first assignment is
16 3 13
I am willing to grade the second assignment for
5 but I receive 16
The Producer Surplus for the second assignment is
16 5 11
I am willing to grade the third assignment for
10 but I receive 16
The Producer Surplus for the third assignment is
16 10 6
I am willing to grade the fourth assignment for
15 but I receive 16
The Producer Surplus for the fourth assignment is
16 15 1
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Review producer surplus
Now, lets get the producer surplus for the total
amount of assignments graded
If I only grade one assignment my producer
surplus is the same as the producer surplus of
grading the first assignment, 13.
13
If I grade two assignments, I get the producer
surplus from the first assignment (13) and the
producer surplus from the second assignment
(11), the total producer surplus of grading two
assignments is 131124
13
11


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If I grade three assignments, I get the producer
surplus from the assignment beer (13), the
producer surplus from the second assignment
(11), and the producer surplus from the third
assignment (6), the total producer surplus of
grading three assignments is 1311630
13

11

6

30
If I grade four assignments, I get the producer
surplus from the first assignment (13), the
producer surplus from the second assignment
(11), the producer surplus from the third
assignment (6), the producer surplus from the
fourth assignment (1), the total producer
surplus of grading four assignments is
13116131
13

11

6

1

31
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Put all the previous information in a table and
in a graph

The producer surplus from the first assignment
is 13
16
Price 16
1
6
15
11
The producer surplus from the second assignment
is 11
10
13
The producer surplus from the third assignment is
6
5
The producer surplus from the fourth assignment
is 1
3
The total consumer surplus for the four
assignments is the shaded area in the graph and
it is equal to 13116131
4
3
2
1
Assignments
10
Review producer surplus
The final issue is to see the producer surplus
for a linear supply curve.
The Producer Surplus is the shaded are below the
price and above the supply curve.

Remember that we graphed the supply curve by
using the data on marginal cost to grade and
quantity.
SMC
P
Quantity
Q
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Producer surplus
Question Why is the Producer Surplus
important? Answer The producer surplus measures
the profit of the producer. Therefore, the
producer surplus is the welfare of the producer.
You can think of the producer surplus as another
way of saying profit. The higher the producer
surplus For example in our previous example
It costs me to 3 to grade one assignment but I
get paid 16. Therefore, I obtain a profit of
16-313 from grading my first assignment. Thus,
the profit and the producer surplus are the
same. The second assignment costs me 5 dollar to
grade but I get paid 16 to grade it. The profit
for the second assignment 16-511, and so on

16
Price 16
1
6
15
11
10
13
5
3
4
3
2
1
Assignments
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Producer surplus and price changes
Now, we are going to analyze how the producer
surplus changes when the price changes. Imagine
that the initial price is P1 and the price
decreases to P2.
When the price is P1 the PS is A B C . When
the price decreases to P2 the PS is now B. The
producer surplus decreases when the price goes
down. This is not surprising, the producer gets a
lower profit when he receives a lower price for
the good sold. The change in PS is given by the
areas A C
S
When the price decreases a lower quantity is
being offered by producers. Hence, the area A
represents the loss in producer surplus to
remaining producer. This producers have costs low
enough that when the price decreases they can
still make a profit and stay in the market. The
area C represents the loss in PS from producers
that are not in the market anymore. These
producer has costs that are higher than the new
price P2 and therefore have to leave the market.

P1 P2
C
A
B
Q
Q1 Q2
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Producer surplus and price changes
Now imagine that the price increases from P2 to
P1
In this case, the producer surplus increases when
the price goes up. The producer gets higher
profits when the price charged for the good
increases. The change in PS is given by the
areas B C
When the price decreases a higher quantity is
being offered by the producers. Hence, the area A
represents the extra producer surplus to
producers that were in the market before the
price increased. The area C represents the
profit to producers that were not in the market
before the price increase.
S
Hence, the area A is the extra PS to old
producers. The area C is the new PS to new
producers.

P1 P2
C
A
B
Q
Q1 Q2