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Producer surplus

Producer surplus is the difference between the price a producer gets and its marginal cost. Explore the concepts of supply and demand, opportunity cost, and producer surplus in the context of a berry farm, learning how changes in quantity produced affects the price needed to incentivize producers, and how producers benefit when the market price is higher than their opportunity cost. Created by Sal Khan.

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  • blobby green style avatar for user missyella29
    At he talked about the producer surplus but i don't really understand it…..can i be given another example to cite a case of producer surplus?
    (10 votes)
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    • starky ultimate style avatar for user Geoff Ball
      Producer surplus is the benefit that firms receive by getting more for their product than the minimum they were willing to accept. Let's use an example.

      Say I'm selling a camera and you want to buy it. I am willing to sell it for no less than $100. You are willing to buy it for no more than $200. We settle on a price of $150 (of course, we don't tell each other our bottom lines).

      I get $50 producer surplus, because I sold it for $50 more than my minimum. You get $50 consumer surplus, because you got it for $50 less than your maximum.

      Now, expand this concept to the whole market. Each consumer will accept a different price, which is how we end up with the downward-sloping demand curve (as price goes up, less people are willing to buy; let's say 10 people would buy for no more than $10, 9 people would buy for no more than $20, 8 people would buy for no more than $30, etc.). Each producer will sell for a different minimum price, which gives us an upward-sloping supply curve (as price goes up, more firms are willing to sell; let's say 2 firms will sell for no less than $10, 3 firms will sell for no less than $20, 3 firms will sell for no less than $30, etc.).

      There is all that surplus because people mutually benefit from trading.
      (104 votes)
  • blobby green style avatar for user ar.verhoefs
    How do we calculate the producer surplus if it is a non-linear curve?
    (20 votes)
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  • leafers tree style avatar for user Gpagach
    Is producer surplus in some cases just basically the producer's profit?
    (12 votes)
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  • blobby green style avatar for user shacktoms
    I wonder about the effect of investment (e.g. automation, mass-production) reducing the cost-per-unit at high quantity. Couldn't that result in a downward-sloping supply curve? It would have to be shallow enough that it didn't pay to simply produce more and throw away the excess. But it might slope downward and still intersect a more steeply sloped demand curve. I think the result would be a modest profit, that had little to do with the (negative) producer surplus found by looking at the curve.
    (12 votes)
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    • mr pants teal style avatar for user Wrath Of Academy
      Yes, as a higher quantity supplied is reached, investments could allow for a lower marginal price for additional unit. This would lead to a downward-sloping supply curve, at least over part of the curve.

      In some industries (magazine publishing for example) there is always a large up-front fixed development cost, so the very first unit is quite expensive. Marginal costs slope downward from there, but at some point might slope back up a bit at the point where (for example) paper suppliers begin running out of inventory and your raw paper costs go up.

      One thing to keep in mind though is that all of these graphs are abstract models that are only relevant in very limited cases. http://mises.org/daily/931 is a nice little article on why one shouldn't take these things too seriously.
      (7 votes)
  • blobby green style avatar for user stenly83

    At the very end of the video you said that "we end up by $6000 of producer surplus PER WEEK" but we have Quantity produced PER YEAR on the horizontal axis. Where this change in is coming from?
    (2 votes)
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  • male robot donald style avatar for user Christopher
    Can the supply curve ever be downward sloping? For example, it would seem that in mass produced goods that it's more expensive per car to produce 100 cars then it is to produce 10,000 cars. If the opportunity cost drops as the quantity supplied goes up, would the supply curve be downward sloping?
    (5 votes)
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    • male robot donald style avatar for user Jordan Manduki
      Just to clarify: In the above example of the corn farmer we need to assume, that he for some reason doesn't have the possiblity to change his product to for example wheat. Normally one would try to produce the product that grosses the highest amount of money. If for some reason the farmer is forced to stay on his corn he will have to produce more of it in order to still make ends meet.
      (1 vote)
  • blobby green style avatar for user Sam Katz
    At , the graph is showing what a producer surplus is going to become. The thing I do not understand is that if the producers are selling 1000 lbs of berries for around $1.00, how are they ending up getting a $3 profit?
    (6 votes)
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    • piceratops sapling style avatar for user MQ
      IF the sellers wish to sell at 1000 lbs, they will get $1.00 BUT in reality they will sell 4000 lbs because that is where the equilibrium between quantity demanded and quantity supplied lies. Thus, for the first pound that they sell they'll get $4.00 where its real value is only $1.00, for the second they'll get let's say $3.99 when its real value is again only $1.00 and so on...
      Hope this helps.
      (3 votes)
  • female robot grace style avatar for user Rey #FilmmakerForLife #EstelioVeleth.
    can someone explain the difference between consumer surplus and producer surplus? thanks!
    (6 votes)
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  • blobby green style avatar for user Parth Arora
    The supply curve doesn't seem to be consistent with the concept of "economies of scale" which states that average cost of production decreases with increasing quantity. What am I missing here?
    (3 votes)
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  • male robot hal style avatar for user Willem Heijboer
    What is the relation between Producer's Surplus and the Producer's profit? Since the supply line can be seen as marginal costs, is the producer's surplus the same as the producers profit minus some fixed costs?
    (5 votes)
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    • orange juice squid orange style avatar for user Owen Sechrist
      Assuming you're asking about profit in the accounting sense it wouldn't be that simple. Keep in mind that the Supply Curve is the producer's opportunity cost which includes calculating the revenue you could have made using resources for another activity, which are not hard costs that you actually incurred.
      You may want to Google "accounting profit vs economic profit" to get more info (including a Khan academy video explaining the difference)
      (1 vote)

Video transcript

We have now talked a lot about the demand curve and the consumer surplus; now let's look at the other side. Let's think about the supply curve and you could imagine that there might be something called the producer surplus. So let's say that this is price axis, this is the quantity axis and let's say that we are running some type of a berry farm and this is our supply curve. That is the supply curve and this is our demand curve. So that is the demand and just like what we did to the supply curve, for the demand curve, now instead of thinking of a price and think about how much quantity would be supplied, let's think about a given quantity and think about what price would it have to be in order for the producers to produce that quantity. And let's say that this quantity right over here, this is in thousands of pounds of berries, thousands of pounds. So this is 1 thousand pounds, 2 thousand pounds, 3 thousand pounds, 4 thousand pounds, and 5 thousand pounds. And let's say this price right over here is 1 dollar per pound, $2, $3, $4, maybe I could make it more even, so this is $3, this is $4, this is $5 per pound. Let me write this all in per pound. So let's say that we want the suppliers to produce 1 thousand pounds of berries, so this is we want them to produce 1 thousand pounds of berries, What does the price have to be for them to produce 1 thousand pounds of berries. Well think of it from the suppliers from the berry farmers' point of view. If they are going to produce 1 thousand pounds of berries. in order for them to produce it, in order to convince them produce it, they have to get at minimum as much as they would get using the same resources to produce something else. So if they could get a dollar per pound or equivalent in dollars of a dollar per pound for those first thousand pounds, so about a thousand dollars. If they could get that by using their land for an apple orchard or using it to graze or maybe renting out the land to someone else, that's the minimum you would have to pay them. Because if you pay them less than that they would go do the other thing. They would go and rent their land out or they will allow their land for grazing. So you would have to pay them the opportunity cost for them to produce a thousand pounds. So the opportunity cost for them to producing a thousand pounds would be right over there. And this is on average first thousand pounds you could also think that the very first pound, the opportunity cost would be right over there, and the next pound would be right after that. The five hundred pound would be there, the thousand pound would right be there. or you could say the first thousand pound on average would be right over there. Now let's say that we wanted them to produce another thousand pounds. So we want the market or this entire farm to produce or maybe it's multiple farms to produce a total of two thousand pounds. What would we have to do? Well, same exact thing. We kind of assuming the market is already producing that first thousand pounds. So now we would have to think about what are they giving up to produce that next thousand pounds. And now we would assume that for that first thousand pounds, they would have used the land and the inputs that are most suitable so this is the most suitable resources. So we are talking about the labour that really knows how to grow berries. The land where the berries are the best grown and maybe they are really close to transportation networks so it's much cheaper to produce and ship from there. But now if we want another two thousand pounds of berries at this time period and maybe this per year if we want another thousand pounds. They are now going to less suitable resources, maybe the land is slightly further away from the transportation resources, they are now going to have labours that are slightly less efficient, they are going have to take land away from that. might have been slightly more suitable for other things. So now the opportunity cost for these growers for the next thousand pounds is going to be slightly higher. So their opportunity cost is going to be like that on average for the next thousand pounds. You could that the opportunity cost for the one thousand pounds will be right over there for the two thousand pounds would be right over there. But on average for the two thousand pounds, this is their opportunity cost now, same thing, the next thousand pounds after that If we want to get the market, if we want the whole supply be three thousand pounds they would have to produce, they would have to get that their opportunity across that incremental thousand pounds that opportunity cost of that incremental thousand pounds. So view it as this way, the supply curve no longer and it is the same exact curve, before we used to say, oh if we want how much would people produce if the price were 3 dollars. Oh they produce 3 thousand pounds, now we are looking at the other way, we are saying if we want the suppliers to produce 3 thousand pounds, what would the price actually have to be. Now with that out of the way, now we can think about the supply curve is really a opportunity cost curve for the suppliers. And let's say that this is supply and the demand, and then this would be the actual price which supply equals demand right over there so let's just say that is the market price. So what's going on over here, all of the suppliers, so this is the price here let's just for making the math simple, let's just say that price here is 4 dollars and the quantity demanded and the quantity supplied here is 4 thousand pounds. What's going on here, the very first 4 thousandth pound produced by the suppliers, the opportunity cost for them to produce it would be 4 dollars. We are gonna get exactly 4 dollars for it so they are right on the fence. but for the first three thousand 999 pounds, the opportunity cost of producing it was lower than the price to get it, so in this situation the producers are getting more, for the first 3999 pounds. They are getting more for their berries than their opportunity cost and just like we talked about, the consumer surplus, this is the producer surplus. So, for example, for the first thousand pounds right here, the producers, their opportunity cost was a little over a dollar a pound but they are getting 4 dollars a pound for it. For the next thousand pounds, the opportunity cost is approaching 2 dollars per pound, like a $1.75, just eyeballing it. Once again, they are getting 4 dollars a pound for it so they are getting this surplus, so if you think about the entire market, the producers as a whole, they are getting this entire area, this entire area represents the excess value that they are getting above and beyond their opportunity cost, and we call this right over here the producer surplus, the producer surplus. And we are assuming or we will assume a linear supply curve right over here. This is just a triangle, the area of a triangle. This length right on this side is just 4-1, it's just 3, 3 dollars per pound and then this length right over here is 4 thousand pounds, 4 thousand pounds. So to find the producer surplus, we are just finding the area of this region. So, let me write this, the producer surplus here is going to be, I will use the same color, 3 times, I want to do it with pink, 3 times the 4 thousand, and that would give us the area of this entire rectangle, so we have to divide it by 2. That's just finding the area of the triangle, so times one half, dividing by 2. And so this gives us one half times 4 thousand is 2 thousand times 3 is 6 thousand. And you could look at the unit, it's 6 thousand or 3 dollars per pound times thousand of pounds per week so we end up with, so the, we end up with 6 thousand dollars of producers' surplus per week.