Producer Surplus
Producer surplus is the amount sellers are paid minus the cost of production. Producer surplus measures the benefit to sellers of participating in a market. The supply curve shown above is defined by the cost the producers face according to the quantity of the goods they produce. This includes all firms on the market whose cost for producing the good is less than the market price; those whose cost is greater than the current price produce no goods or else they would lose money. For example, if the market price is $140 per good, then the profiting firms produce 100 units for the market.
Supposing all of the goods are sold, the producers receive $140 per unit for 100 units, a total of $14,000, represented in the graph as the area under the line BC. However, they must then pay off the cost of producing these goods, depicted by the area under the supply curve and to the left of the quantity sold (100 units), a total cost of $8500. To find the producer surplus, we subtract the sellers’ cost from the total amount the sellers are paid, giving a total of $5500. From the graph, we deduce that producer surplus is measured by the area below the price, above the supply curve, and to the left of the quantity bought.
Now suppose that the price of the good goes up to $200 apiece. Before the price hike, some firms whose cost of producing each good was greater than $140 could not produce the good because the price rendered it unprofitable. Now that the spending cap has been raised to $200, more producers can enter the market, so more goods can be manufactured, increasing the quantity in accordance with the supply curve. The increase in price also yields a larger triangle in the supply graph, thus a greater producer surplus. But how is this new surplus distributed?
In the picture above, the entire triangle (shaded in gray, teal, and blue) represents the new producer surplus. Before the price increase, the producers supplying the original 100 units received a surplus below the $140 price tag, above the supply curve, and to the left of the 100-unit mark. Now that the price has risen, the cost and number of units stay the same while the producer surplus increases. The cost of producing the 100 units is still $8500, but now the producers receive $200 per unit for 100 units, earning them $20,000. When we subtract the cost from the earnings now, we get $11500. The producers already got $5500 of this total from their initial surplus, but the additional $6000 comes from the price increase on products they were already selling. This new surplus is measured graphically by the teal rectangle between the old and new prices, which sure enough adds up to the extra $6000.
Now we shall see how the newest producers in the market get a slice of the pie. Because new producers are responsible for the increase in quantity from 100 to 150 units, we measure the area below the price and above the supply curve within this 50-unit range to get these producers’ surplus. The result is the area of the blue triangle on the graph, which we measure to get $1500.