Consumer and Producer Surplus

Producer Surplus

Producer surplus is the difference between the minimum price a seller is willing to accept for a good or service and the actual market price the seller receives.
The amount consumers are willing to pay for goods and services and the amount sellers are willing to accept determine prices in a free-market economy. In other words, the market sets the price goods and services. If the market price is lower than the minimum amount that a producer is willing to accept, the producer will choose not to sell. However, if the price is higher than their minimum price then not only will they sell, they also have an added benefit: a gain from trade called producer surplus, which is the difference between the minimum price at which an individual supplier (or the market) would be willing to sell a good or service and the actual market price that they receive. This gain exists because the producer is receiving a price that is greater than their supplier's cost—not only is it covering the cost of producing that unit of output (i.e., marginal cost), but they are earning some extra money as well.

Just as every consumer has a maximum price at which they are willing to buy, every producer has a minimum acceptable price at which they are willing to sell. At the very least, they want to cover their costs. This minimum price at which an individual producer is willing to sell is known as the seller's cost. Any time that a store advertises that they are "selling at cost," this is what they mean. In this case, they are not making any profit on the sale; they are just breaking even. In terms of production, in economics the lowest acceptable price is typically defined as the price that covers a firm's marginal cost—the additional cost that the firm incurred by producing that one particular unit of output.

The supply schedule, a table that shows the quantity supplied of a good at different prices, shows the different minimum prices at which six coffee shops are willing to sell a cup of coffee.

Supply Schedule for Coffee
Potential Seller Minimum Price (Seller's Cost)
Rise 'N' Shine $0.50
Super Cup $1.00
Hot Cuppa $1.50
The Brown Bean $3.50
The Koffee Kup $4.00
Finest Grounds $6.00

The supply schedule for coffee shows us the price at which each producer is willing to sell (seller's cost).

This supply schedule can be used to create a supply curve, a graphical representation that shows the quantity supplied at different prices, which can also be used to show the maximum amount of a good or service that an individual producer (or the supply side of the market) would be willing to produce.

Supply Curve for Coffee

The market for coffee only has six potential producers, so the supply curve for coffee is step-shaped. Each step represents one seller, and the height of the step is equal to their minimum acceptable price, known as the seller's price.
Each producer's minimum acceptable selling price corresponds to a spot on the market supply curve. Note that the supply curve is upward sloping, indicating that as the price of a cup of coffee goes up market supply of coffee increases. Producers and sellers can succeed when the market price for the good or service they offer is above the marginal cost. Each seller's producer surplus is the area above their step on the supply curve and below the market price. The total producer surplus is the area above the supply curve and below the market price.

Producer Surplus for Coffee

Each firm's producer surplus is the difference between the market price and the price that is the minimum acceptable to them (i.e. their seller's price). Any firm whose seller's price is above the market price ($2.00) chooses not to sell.