The producer surplus is the difference between the production costs of a product (reservation price ) and the equilibrium price. In other words, it is the net advantage that a company receives from the sale of a product if it can sell it above the reserve price. However, the producer surplus is not to be equated with the profit. The producer surplus is opposed to the consumer surplus. Both together serve to determine economic welfare.
In this lesson we explain the concept of producer surplus and how it is calculated. We explain the importance of producer surplus for companies and its influence on welfare. You will then have the opportunity to check your knowledge with a few exercise questions.
English: Producer Surplus
Why should you know the producer surplus?
According to sportingology.com, the producer surplus is an important indicator of economic welfare, which shows the benefit of the individual or the benefit of all individuals in an economy. It can be used to show how economically a company is able to produce.
Accordingly, a high producer surplus indicates a high level of profitability.
However, the term producer surplus can be a bit misleading as it is not an economic pension, i.e. income without consideration. Rather, what is meant is a reward given to those companies that can produce more cheaply than the marginal supplier.
Differentiation between producer surplus and profit
Producer surplus is often confused with profit. However, there are two main features that set it apart from him.
Producer surplus
The producer surplus is the difference between the actually generated revenue and the variable costs.
Profit
The profit is calculated by subtracting the total cost from the proceeds. It therefore takes into account both the variable and the fixed costs.
Producer surplus in the supply and demand function
What does the producer surplus say?
The producer surplus provides important insights into the cost structure of a company. The market price always corresponds to the total costs of the provider who can barely stay on the market with it. This is why this is also referred to as a border provider. All other companies that are able to produce more cheaply and at the same time can charge the same price generate a producer surplus in contrast to the marginal supplier.
Example producer surplus
Example
A manufacturer of solar modules sells the individual module for € 800, which is the market price. However, the production costs per module are only € 700, which is why he earns a producer surplus of € 100.
Producer’s rent with restricted competition
In the course of a perfect price differentiation, a provider can receive the sum of producer and consumer surplus and thus achieve maximum welfare.
Price differentiation means charging different prices for the same product or service. The provider tries to make the most of his customers’ willingness to pay and thus reduce their consumer surplus.
However, no statements can be made with regard to profit from the welfare maximum alone, since the company’s cost structure would have to be known for this.
Example producer surplus and welfare maximum
Example
The above-mentioned manufacturer of solar modules is facing increasing demand due to government subsidy programs.
His research shows that the equilibrium price has risen to € 850. However, its production costs of € 700 per module have remained unchanged. In addition, market research has shown that customers are willing to pay up to € 900 per module.
He adjusts the price accordingly and can earn the following pensions:
He thus achieves a total of € 200 in pensions, which significantly increases his welfare from a microeconomic point of view.