Producer surplus definition (how to calculate with example)

By Indeed Editorial Team

Published 28 June 2022

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

Exchanging goods in the marketplace may sometimes create a surplus for sellers (producers), which can be highly beneficial for their businesses. Before sellers can benefit from a surplus, sellers have to sell their goods to buyers and buyers have to buy goods from sellers. Learning about the concept of producer surplus and its contribution to market efficiency can be helpful for both companies and economists. In this article, we review the producer surplus definition and examine the difference between producer surplus and consumer surplus, including how to calculate producer surplus with examples.

What is the producer surplus definition?

The definition of producer surplus is the extra gain that producers enjoy when they sell a product at a higher price than they may be willing or able to sell. It's the difference between the price that a seller can sell a particular product for and the actual market price. For example, a market for tomatoes consists of several vegetable farmers who have different prices for their tomatoes. Some farmers may be more productive and efficient than others, meaning they can produce tomatoes at a much lower marginal cost.

These farmers can afford to sell their tomatoes at a much lower price than they could sell them for at the market. So, the most productive farmers earn lots of producer surplus when they sell tomatoes at the market price. The less efficient farmers may produce lower quantities of vegetables due to certain factors, such as high rent or high staff wages. These farmers enjoy less producer surplus since the market price is closer to the price that they're willing and able to sell to customers.

Related: How to calculate marginal cost and why it's useful

Producer surplus vs consumer surplus

The following shows the difference between producer surplus and consumer surplus:

Definition of consumer surplus

Consumer surplus represents the difference between what a consumer is willing to pay for a product and the actual amount they pay to purchase a product. In contrast, producer surplus represents the difference between what a producer is willing to sell a product for and the actual amount they sell the product for. While producer surplus is the variance between the actual price a seller sells a commodity and the minimum acceptable price, consumer surplus is the difference between the maximum amount of money consumers are prepared to pay for a product and the actual cost.

Related: What is consumer surplus? (With definitions and examples)

Economic welfare

Economic welfare refers to the satisfaction individuals derive from exchanging goods and services. Producer surplus is the producer's welfare, while consumer surplus is the consumer's welfare. Economic welfare, also known as the community surplus, is calculated by adding the producer and consumer surplus.

Graphical representation

On a graph, the producer surplus is the area above the supply curve and below the equilibrium price. The consumer surplus is the area under the demand curve and above the equilibrium price. Companies can also calculate both market conditions. The following is the formula to calculate producer surplus:

Producer surplus = (Market value – Minimum selling price) × Quantity

The following is the formula to calculate consumer surplus:

Consumer surplus = Maximum amount consumers may pay – Market value

Related: What is market structure? (Definition and examples)

How to calculate producer surplus using a formula

The following are steps to calculate producer surplus using a formula:

1. Determine the minimum selling price

In a market space, sellers use certain economic costs to measure how far they may adjust the price of a commodity. Since there are several producers with varying prices, the minimum price of any product is the amount at which the seller may be willing to sell that product. When calculating producer surplus, note that the most efficient producers enjoy maximum producer surplus. In contrast, the less efficient producers may hold little or no producer surplus because the prices of their products are closer to the market price.

Related: 5 popular manufacturing and production strategies

2. Determine the market price

The market price is the most current price of a product. It's also the equilibrium price where the forces of supply and demand meet. There are different participants in a market space, such as the sellers and the buyers. Sellers want to charge as much as possible, while the buyers want to pay as little as possible. This process creates a necessity for balance. The market price serves as a mid-price that establishes the balance between the participants in a marketplace. Factors such as the product's uniqueness and availability also influence the market price.

3. Determine the number of products sold

The quantity of products a seller sells at a particular time refers to the number of units sold. For example, a coffee shop sells coffee in different cup sizes that the customer can choose from. If a customer requests two big cups of coffee, the two big cups represent the quantity sold.

4. Calculate the producer surplus

Using the formula, insert the appropriate values to replace each variable. This action means that you can subtract the value of the minimum selling price from the market value. Then, you can multiply the result by the number of products sold.

Related: How to calculate net cash flow (and why it's important)

How to calculate producer surplus using a graph

The following includes steps to calculate producer surplus using a graph:

1. Draw the supply curve

The supply curve indicates the marginal cost of production. It explains the relationship between price and the number of products a producer can supply. On the graph, you can plot the quantity of output on the X-axis and price on the Y-axis. On the Y-axis, locate the price the producer is willing to sell the product for and note it with a variable, such as a point labelled Q.

2. Locate the point of intersection

The point of intersection is where the supply and demand curves meet and represents market equilibrium. Use a variable to denote the point of intersection, such as a point labelled X. Draw a parallel line from the market price on the Y-axis through the point of intersection to meet the X-axis. This action causes the supply curve to form two right angles.

Related: Supply and demand diagram (definition, types and examples)

3. Calculate the producer surplus

The area of the upper triangle formed is the producer surplus. Calculate the producer surplus by calculating the area of this triangle. You can do this by multiplying the length by the height and dividing by two.

Related: What is importing and exporting? (With practical examples)

Examples of producer surplus

Imagine there's a producer who manufactures electric blenders. The manufacturing cost of a single blender is around £6, but the producer is willing to sell the product for £10. If there's an increase in demand, the market price of the blender can rise to £15. Determine the producer surplus for the manufacturer if it sold 40,000 pieces in a year. This example provides the following information:

Minimum selling price = £10

Market price = £15

Quantity = 40,000 pieces

Using the formula for producer surplus, you can calculate the following:

Producer surplus = (Market value – Minimum selling price) × Quantity

Producer surplus = (15 – 10) x 40,000

Producer surplus = 5 x 40,000

Producer surplus = £200,000

This means that the producer earns a producer surplus of £200,000 in a year.

This next example lets you find the producer surplus for a single product by replacing the quantity sold with one. Using the formula, you can calculate the producer surplus for a single product:

Producer surplus = (Market value – Minimum selling price) × Quantity

Producer surplus = (15 – 10) x 1

Producer surplus = 5 x 1

Producer surplus = £5

This means the producer surplus is £5 on each electric blender that the producer sells.

FAQ about producer surplus

Here are a few FAQs about producer surplus:

Why is producer surplus important?

Producer surplus can serve as a marker to determine the equilibrium price of a product. It can also serve as a reward system for producers who spend their resources running a business more efficiently. Some companies may earn less than they spend at some point in their operations, so producer surplus can serve as an incentive to help business owners recover from losses.

Is producer surplus the same as profit?

There are key differences between producer surplus and profit, although they both represent gains from transactions. Profit is the total revenue minus expenditures that a seller receives in exchange for a product. In contrast, producer surplus is the extra revenue from the sale of a product minus the marginal and direct cost of producing that product.

Related: How to calculate profit margin with a profit margin formula

How does producer surplus contribute to market efficiency?

Markets are efficient when the consumer and producer surpluses are at a maximum. This means that efficiency occurs when the maximum amount consumers are willing to pay equals the minimum acceptable price. Without market efficiency, it may be challenging for one party to benefit from a transaction without imposing costs on others.

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