What is a Producer Surplus?

A producer surplus is the figure that represents the difference between the minimum amount that the producer would be willing to receive for a product and the actual amount that is received for that product. This type of surplus is applied to the sale of just about any type of good or service, and is sometimes related back to the profit margin that the manufacturer must generate in order to make the production of those goods or services viable. In this sense, calculating producer surplus requires that the producer know exactly how much it costs to produce each unit for sale, and what he or she considers to be the minimum in terms of profit that would motivate the producer to continue manufacturing that product.

There are a number of factors that go into determining the base figures that make it possible to identify an equitable producer surplus. In determining the minimum amount that is considered necessary to earn from each unit sold, the producer will look closely at every cost involved with the creation, marketing, and delivery of that unit. After allowing for total costs associated with the unit, the producer then sets a minimum sales price that serves as the lowest amount that the producer is willing to accept for the product. This minimum price may serve as the basis for the producer surplus, or the producer may add an additional amount to that minimum price, as a cushion to offset losses in the event that not all units produced sell as quickly as anticipated.

Once the minimum accepted price is identified, it is a simple task to compare that price with the actual price that consumers pay for the product. This difference between the two will represent the producer surplus. The amount of surplus generated is often driven by consumer demand; if customers want more of the product, then the market may allow a higher retail price than the producer anticipated, which in turn leads to increased volume in sales as well as earning more per unit sold. At the same time, a lack of demand will lead to lower sales volumes and possibly require selling the product at a unit price that is below the desired price, a situation that would greatly diminish producer surplus.

Many companies monitor both the costs of production and the market demand when determining identifying the amount of producer surplus generated. The issue of competition from other companies that could cut into the producer’s client base is also often a factor when it comes to setting that desirable minimum price. For this reason, businesses tend to re-evaluate the basis for calculating producer surplus as market conditions and demand shifts over time.