Producer Surplus

What is producer surplus? Producer surplus is the producer's gain from exchange. It's the difference between the market price and the minimum price at which producers would be willing to sell a given quantity. And total producer surplus is the sum of the producer's surplus of all sellers. What this means graphically is that total producer surplus is measured by the area above the supply curve and below the price.

To see this, let's look at the market for oil. Here's our supply curve. Suppose that the price of a barrel of oil is $40, and the producer surplus at that price is this blue area. We can think of this as the producer surplus at the lowest cost to suppliers. plus the producer surplus at the second lowest, plus the producer surplus at the third lowest, the fourth lowest, and so forth, until we get to the marginal supplier. And notice that this supplier on the margin earns no producer surplus at all. For this supplier, their costs are just basically equal to the price. They're not earning any producer surplus.

We can calculate these areas using the formula for the area of a triangle: ½ (base x height) So in this instance, producer surplus is ½ x the base, or the quantity of barrels sold, x the height, or the price of oil. Now, we can calculate producer surplus at this price and quantity, but how are price and quantity determined?