Producer Surplus

Consider the benefits sellers receive from participating in a market. As you will see, our analysis of sellers’ welfare is similar to our analysis of buyers’ welfare.

Cost and the willingness to sell

Imagine now that you are a homeowner, and you need to get your house painted. You turn to four sellers of painting services: Mary Frida, Georgia and grandma. Each painter is willing to do the work for you if the price is right. You decide to take bids from the four painters an auction off the job to the painter who will do the work for the lowest price.

Cost: the value of everything a seller must give up to produce a good.

Each painter is willing to take the job if the price she would receive exceeds her cost of doing the work. Here the term cost should be interpreted as the painters’ opportunity cost: It includes the painter’s out-of-pocket expenses (for paint, brushes and so on). The value that the painter’s place on their own time. Because a painter’s cost is the lowest price she would accept for her work, cost is a measure of her willingness to sell her services. Each painter would be eager to sell her services at a price greater than her cost, and she would refuse to sell her services at a price less than her cost. At a price exactly equal to her cost, she would be indifferent about selling her services: She would be equally happy getting the job or walking away without incurring the cost.

Table: The costs of four possible Sellers

Seller Cost

Mary $900
Frida 800
Georgia 600
Grandma 500

When you take bids from the painters the price might start off high, but it quickly falls as the painters compete for the job. Once Grandma has bid $600 (or slightly less), she is the sole reaming , Grandma happy to do the job for this price because her cost is only $500, Mary, Frida and Georgia are unwilling to do the job for less than $600 Note that the job goes to painter who can do the work at the lowest cost.

Producer surplus: the amount a seller is paid for a good minus the seller’s cost of providing it.

What benefit does grandma receive from getting the job? Because she is willing to do the work for $500 but gets $600 for doing it, we say that she receives producer surplus of $100. Producer surplus is the amount a seller is paid minus the cost of production. Producer surplus measures the benefits to sellers of participating in market.

Now consider a somewhat different example. Suppose that you have two houses that need painting. Again, you auction off the jobs to the four painters. To keep things simple, let’s assume that no painter is able to paint both the houses and that you will pay the same amount to paint each houses. Therefore the price falls until two painters are left.

In this case, the bidding stops when Georgia and Grandma each offer to do the job for a price of $800 (or slightly less). At this price, Georgia and Grandma are willing to do the work and Mary and Frida are not willing to bid a lower price. At a price of $800 Grandma receives producer surplus of $300 and Georgia receives producer surplus of $200. The total producer surplus in the market is $500.

Using the Supply Curve to measure producer surplus:

Just as consumers’ surplus is closely related to the demand curve, producer surplus is closely related to the supply curve. To see how, let’s continue our example.

We begin by using the costs of the four painters to find the supply schedule for painting services. The table below shows the supply schedule that corresponds to the costs in Table 2, if the price is below $500 none of the four painters is willing to do the job, so that quantity supplied is zero. If the price is between $500 and $600 only Grandma is willing to do the job, so the quantity supplied is 1. If the price is between $600 and $800, Grandma and Georgia are willing to do the job, so the quantity supplied is 2 so on. Thus, the supply schedule is derived from the costs of the four painters.


The supply schedule and the supply curve

Price Sellers Quantity supplied

$900 or more Mary, Frida, Georgia, Grandma 4

$800 to $900 Frida, Georgia, Grandma 3

$600 to $800 Georgia, Grandma 2

$500 to $600 Grandma 1

Less than $500 None 0