Producer_surplus_Slides_630_430_2009

Producer_surplus_Slides_630_430_2009 - The Concept of...

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The Concept of “Producer surplus” Producer maximizes profit How much better off with a policy change? Or amount taken away without making the firm worse off? Profits a good measure of producer welfare except if forced to shut down The benefit from remaining in business is profit (π) + fixed costs (FC) Fixed costs are sunk - so in the short run, if the firm produces nothing, the loss will be the fixed costs. So we need an alternative to π for a measure of producer surplus if choice is to shut down versus remain in production Producer: o faces fixed input prices o rents or owns fixed factors (assume rental price cannot change or value of owned asset @ opportunity cost @ beginning of time period) Economic Profit : π = TR - VC - FC The gains to a firm from production is the difference between total revenue and total variable costs (where marginal cost is equal to price) Producer surplus: PS = π + FC If fixed costs are sunk, rents to owners of fixed factors are unaffected by policy changes. 2 scenarios: (1) If price increases to P 1 (with a tariff, subsidy etc.), then how much better off is the firm? Change in profits is a good measure (2) What if the producer is forced out of business? Change in profits is not a good measure. Why? Because of fixed costs so both a short run and a long run exit price. 1
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A firm produces a commodity using both variable and fixed costs. The firm is willing to pay more than the current profit to stay in business, so if profit CV ≠ EV if policy is to shut down firm CV = $ when taken away leaves firm as well off if stays in production EV = $ when leaves firm as well off if it shuts down Compensating Variation (CV) for Producers (opposite for consumers) Amount of income that must be taken away (given to) after a new situation (∆ in p, y etc.) to restore original welfare level (or be as well off as in initial situation) Amount of $ to get back to original profit level Equivalent Variation (EV) for Producers (opposite for consumers) Amount of income that must be given in lieu of new situation (∆ in p, y etc.) to attain new welfare level (or be as well off at new situation) Amount of $ to stay at new profit level -------Figures 1 and 2------ i.e. willing to pay more than current profit (area a ) to stay in business (profits underestimate benefits of doing business because of fixed costs). Only if give firm areas
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Producer_surplus_Slides_630_430_2009 - The Concept of...

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