All producers must tag a reasonable price on their commodity in order to convince consumers to choose and use their products.
On the other hand, producers look forward to receive certain minimal amount in return of their goods and services, without which they won’t be able to generate profit.
Producers set certain amount of price for their goods and services, depending upon different inputs that are used during the production procedure. However, sometimes, consumers may be willing to pay price greater than that set by the producers due to various market condition.
This difference between the minimum price that the producers are willing to supply or sell their commodity at and the actual price they receive from consumers in exchange of the commodity is known as producer surplus or producer welfare. The difference amount or surplus is additional benefit that the producers gain through selling their products.
For instance, let us suppose, ABC is a firm which produces rain boots. After careful evaluation of cost of production and desired profit, the firm decided to sell its product at dollar 40 per pair. The firm produced 1000 pairs and distributed in the market. However, due to availability of limited amount of boots, consumers became ready to pay dollar 50 for a pair.
If the firm had sold all 1000 pairs of rain boots for dollar 40 per pair, it would have earned revenue of dollar 40,000. But, since the firm was able to sell each pair for dollar 50, it gained total revenue of dollar 50,000, generating producer surplus of dollar 10,000.
Figure: graphical representation of producer surplus
Graphically, producer surplus is the area above the supply curve and below the equilibrium market price.
In the given figure, DD is a linear demand curve, SS is a linear supply curve and O is the point of equilibrium where Q amount of commodity is supplied at price P. Thus, in the above figure, area of ΔNOP gives producer surplus.