Definition: Producer surplus is an economic calculation that measures the difference between the price a company actually sells a product for and the minimum amount of money that it would accept for the product. This difference between the amount received from the customer and the minimum set price of the product is the surplus.
What Does Producer Surplus Mean?
What is the definition of producer surplus? Each producer deems a different efficiency for producing a product. Still, in a perfectly competitive market, producers sell their products in order to make a profit. Businesses achieve a profit occurs when their costs of production are lower than the market equilibrium price.
When the equilibrium price increases above what the company is willing to accept for the product, it receives a surplus from the consumers.
Let’s look at an example.
Example
Specialty goods like luxury cars or professional services normally sell for a higher price than convenience goods or shopping goods. They also are more rare and produced less than homogeneous goods and services. Thus, their prices and their producers’ profits can change greatly based on demand. Let’s consider Rolls Royce for example.
Rolls Royce produces expensive, high-end luxury cars that have a limited demand. Let’s assume that Rolls produces 100 cars each year and the worldwide demand for these types of cars is 100. Thus, they would sell all 100 cars at their asking price of $300,000 each totaling $30,000,000 in revenues.
The next year the stock market does really well and increased consumer spending. This, in turn, increases the demand for these luxury cars to 200. Since the demand increased but the supply stayed the same, the price that consumers are willing to pay for the product will increase. This year consumers are willing to pay $400,000 for each car.
Thus, Rolls Royce will sell all 100 of the cars it produced during the year to customers for $400,000 each totaling $40,000,000 in revenues. The difference between the $40M in revenues and the $30M in revenues in the pervious year is the producer surplus.
It’s the different between the amount customers paid for the product ($400k) and the minimum amount that Roll Royce would accept for the product ($300k).
Let’s look at another example.
Bernard specializes in woodworking. Every morning before the sun rises, he treks up to his woodshop and works from sunrise to sunset. He builds tables, scones, doorframes, and even novelty items like nutcrackers. This particular day Bernard felt very energized and made way more than his usual number of duck decoys. He had so many he ran out of room to put them.
Today happened to be the day, Bernard hosted the local swap meet where other craftsmen attempt to sell their creations before they hit retailers. Bernard created the rules and provisions of this sale. One rule is that each item must be appropriately labeled with a price tag.
Bernard believes that if he sold all of his excess decoys, he could make around $500.00? He had 10 decoys and each was labeled $50 dollars. Each duck was unique but one particular all white duck seemed to catch the attention of several attendants. The price tag says $50 but one woman tells Bernard she will pay $65. A man behind her overheard and offers to pay $85.00, no one counters his offer and Bernard accepts $85. Bernard just made an additional $35 to what he was willing to accept. Thus, he experienced a producer surplus.
Bernard and all of the other craftsmen always try to increase their producer surpluses. Allowing the participants to bid allows some of the items to sale at higher prices and makes it easier to match the demand.
Summary Definition
Define Producer Surplus: Producer surplus means the difference between the actual amounts paid by buyers and the minimum amount a producer will accept. It is the additional benefit the producer receives.
