Producer Surplus: Definition, Formula, and Example

What Is a Producer Surplus?

Producer surplus is the difference between how much a person would be willing to accept for a given quantity of a good versus how much they can receive by selling the good at the market price. The difference or surplus amount is the benefit the producer receives for selling the good in the market.

A producer surplus is generated by market prices in excess of the lowest price producers would otherwise be willing to accept for their goods. This may relate to Walras' law.

Key Takeaways

  • Producer surplus is the total amount that a producer benefits from producing and selling a quantity of a good at the market price.
  • The total revenue that a producer receives from selling their goods minus the marginal cost of production equals the producer surplus.
  • Producer surplus plus consumer surplus represents the total economic benefit to everyone in the market from participating in production and trade of the good.
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Producer Surplus

Understanding Producer Surplus

A producer surplus is shown graphically below as the area above the producer's supply curve that it receives at the price point (P(i)), forming a triangular area on the graph. The producer’s sales revenue from selling Q(i) units of the good is represented as the area of the rectangle formed by the axes and the red lines, and is equal to the product of Q(i) times the price of each unit, P(i).

Because the supply curve represents the marginal cost of producing each unit of the good, the producer’s total cost of producing Q(i) units of the good is the sum of the marginal cost of each unit from 0 to Q(i) and is represented by the area of the triangle under the supply curve from 0 to Q(i).

Subtracting the producer’s total cost (the triangle under the supply curve) from his total revenue (the rectangle) shows the producer’s total benefit (or producer surplus) as the area of the triangle between P(i) and the supply curve.

The Formula for Producer Surplus Is:

Total revenue - marginal cost = producer surplus

The size of the producer surplus and its triangular depiction on the graph increases as the market price for the good increases, and decreases as the market price for the good decreases.

Producer Surplus
Image by Julie Bang © Investopedia 2019

Special Considerations

Producers would not sell products if they could not get at least the marginal cost to produce those products. The supply curve as depicted in the graph above represents the marginal cost curve for the producer.

From an economics standpoint, marginal cost includes opportunity cost. In essence, an opportunity cost is a cost of not doing something different, such as producing a separate item. The producer surplus is the difference between the price received for a product and the marginal cost to produce it.

Because marginal cost is low for the first units of the good produced, the producer gains the most from producing these units to sell at the market price. Each additional unit costs more to produce because more and more resources must be withdrawn from alternative uses, so the marginal cost increases and the net producer surplus for each additional unit is lower and lower.

Producer Surplus vs. Profit

Profit is a closely-related concept to producer surplus; however, they differ slightly. Economic profit takes revenues and subtracts both fixed and variable costs. Producer surplus, on the other hand, only takes off variable (marginal) costs.

Consumer Surplus and Producer Surplus

A producer surplus combined with a consumer surplus equals overall economic surplus or the benefit provided by producers and consumers interacting in a free market as opposed to one with price controls or quotas. If a producer could price discriminate correctly, or charge every consumer the maximum price the consumer is willing to pay, then the producer could capture the entire economic surplus. In other words, producer surplus would equal overall economic surplus.

However, the existence of producer surplus does not mean there is an absence of a consumer surplus. The idea behind a free market that sets a price for a good is that both consumers and producers can benefit, with consumer surplus and producer surplus generating greater overall economic welfare. Market prices can change materially due to consumers, producers, a combination of the two, or other outside forces. As a result, profits and producer surplus may change materially due to market prices.

Producer Surplus Example

Say that there are 20 companies that make widgets, each producing them at slightly different costs. ranging from $2.50 to $3.50 per widget. In the market, there is an equilibrium point where the amount of widgets supplied meets demand at $3.00.

The producer surplus would define those producers who can make widgets for less than $3.00 (down to $2.50), while those whose costs are up to $3.50 will experience a loss instead. For the lowest-cost producer, they would enjoy a surplus of $0.50 per widget.

How Do You Measure Producer Surplus?

With supply and demand graphs used by economists, the producer surplus would be equal to the triangular area formed above the supply line over to the market price. It can be calculated as the total revenue less the marginal cost of production.

What Is Producer Surplus Simply Put?

Put simply, the producer surplus is the difference between the price that companies are willing to sell products for and the prices that they actually get for them. 

What Is Total Surplus?

Total economic surplus is equal to the producer surplus plus the consumer surplus.

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