Consumer and Producer Surplus

How Changing Prices Affect Producer Surplus

How Changing Prices Affect Producer Surplus

Increases and decreases in market price impact producer surplus.
A seller that has a producer surplus (the amount above the market price above which goods and services are sold) makes enough money to cover costs and make a profit. But if the producer surplus falls to zero (the market price is equal to the seller's cost, the minimum price a seller can accept), some sellers may likely go out of business. Consumers are impacted when sellers exit the market.

A Price Increase Affects Producer Surplus

A price increase causes producer surplus to increase.
For example, the minimum acceptable price (seller's price) of a cup of coffee sold by six different coffee shops varies from $0.50 to $6.00. In a particular market, the market price of a cup of coffee is $2.00. Coffee shops whose minimum acceptable price is over $2.00 will not sell in this market. The coffee shops whose minimum acceptable price is under $2.00 will sell in this market, and have a producer surplus. If the market price of a cup of coffee rises to $3.00, those coffee shops will have an increased producer surplus. Coffee shops whose minimum acceptable price is over $3.00 still will not enter this market. However, the three existing sellers can now get a higher price for their coffee. This will cause an increase in total producer surplus.
Producer Surplus When the Price of a Cup of Coffee Increases to $3.00
Potential Customer Minimum Acceptable Price Old Price Individual Producer Surplus at Old Price New Market Price New Individual Producer Surplus
Rise 'N' Shine $0.50 $2.00 $1.50 $3.00 $2.50
Super Cup $1.00 $2.00 $1.00 $3.00 $2.00
Hot Cuppa $1.50 $2.00 $0.50 $3.00 $1.50
The Brown Bean $3.50 - - - -
The Koffee Kup $4.00 - - - -
Finest Grounds $6.00 - - - -
TOTAL Producer Surplus (old price) = $3.00 TOTAL Producer Surplus (new price) = $6.00

When the price of coffee increases, producer surplus also increases at both the individual and total levels.

A Price Increase Affects Producer Surplus

When producer surplus increases, the price a supplier receives for a good or service increases. The additional money can be spent elsewhere in the economy. Even if a business uses this money to expand, this spending will have an impact on the wider economy. For example, coffee shops with a producer surplus might decide to hire more staff, advertise to attract more customers, or buy a fleet of trucks to sell coffee to people that cannot get to their shop.

A Price Decrease Affects Producer Surplus

A price decrease causes producer surplus to decrease.
A decrease in price will also affect producer surplus. As in the case of a price increase, if nothing else has changed for the sellers (meaning that they face the same costs as before), they each have the same minimum acceptable price as before. If the costs for the seller remain constant, a decrease in market price from the original price of $2 will result in a decreased producer surplus.
Producer Surplus When the Price of a Cup of Coffee Decreases to $1.00
Potential Customer Minimum Acceptable Price Old Price Individual Producer Surplus at Old Price New Market Price New Individual Producer Surplus
Rise 'N' Shine $0.50 $2.00 $1.50 $1.00 $0.50
Super Cup $1.00 $2.00 $1.00 $1.00 $0
Hot Cuppa $1.50 $2.00 $0.50 $1.00 -
The Brown Bean $3.50 - - - -
The Koffee Kup $4.00 - - - -
Finest Grounds $6.00 - - - -
TOTAL Producer Surplus (old price) = $3.00 TOTAL Producer Surplus (new price) = $0.50

When the price of coffee decreases, the producer surplus also decreases at both the individual and total levels. One seller, Hot Cuppa, has left the market as a result of the price decrease.

A Price Decrease Affects Producer Surplus

If the market price for a cup of coffee at a coffee shop drops from $2.00 to $1.00, the producer surplus of each coffee shop is affected. For example, if the market price for a cup of coffee is $2.00, each coffee shop selling coffee will have a producer's surplus based on the market price minus its seller's price. If, for Rise 'N' Shine Coffee Shop, the seller's price is $0.50, when the market price is $2.00 Rise 'N' Shine has a producer surplus of $1.50. If Super Cup's seller's price is $1.00, it's producer's surplus is $1.00. If the market price of a cup of coffee drops to $1.00, Rise 'N' Shine's producer's surplus drops to $0.50. Super Cup's producer's surplus drops to $0. Each seller's minimum available price has not changed. However, the lower price has affected their producer surplus.

However, a decrease in producer surplus can have an impact on producers' behavior. In Super Cup's case the new market price is equal to their seller's price—its producer surplus is zero. It is still in the market but is only breaking even (covering marginal costs). Another coffee shop, Hot Cuppa, has a seller's price of $1.50. When the market price drops to $1.00, Hot Cuppa has no producer's surplus and also cannot cover costs. Therefore, Hot Cuppa shuts down, exiting the market.

This can have an impact on the wider economy. One seller has left the market, and of the two remaining sellers, only Rise 'N' Shine is doing better than just covering cost. All the sellers may be very cautious about their spending. These sellers likely have employees whose wages may be affected as well, and this can have ripple effects throughout the economy. Employees who work at a business are also consumers in the larger economy. Decreased wages lead to decreased consumer spending. Finally, when a seller exits the market, consumers' choices are reduced. When Hot Cuppa leaves the market, consumers in this market have less choice about where to buy a cup of coffee.