No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Four: Supply 95 PRODUCER SURPLUS Just as consumers receive a gain in utility when they engage in voluntary trade, so do producers. The market price exceeds some producers’ marginal costs; therefore, they will be able to sell their products at a price greater than their marginal opportunity costs. Figure 4.6 illustrates this area of producer surplus. The shaded area above the supply curve but below the equilibrium price is the producer’s surplus. From our market supply curve in Figure 4.2 , let’s say that the market equilibrium for AirPods is $400 after the initial worker sabotage. At that price, both Javier and Megan will sell AirPods, even though they would have been willing to sell at lower prices. Javier, for example, would have been willing to sell four AirPods at only $200, yet he’ll receive $400. This positive utility gain is known as the producer’s surplus . Don’t leap ahead yet on this concept; the area is producer surplus and is not necessarily the profit of a firm. We’ll cover profit in chapter 6. ELASTICITY Just as with demand, supply may be inelastic or elastic. Understanding whether a market supply is elastic or inelastic helps us understand producer behavior as prices change. Let’s begin with the definition of the elasticity of supply , which measures the responsiveness of the quantity supplied to a change in price. The formula is very similar to the formula for elasticity of demand (since both are measuring responsiveness). However, due to the law of supply, the elasticity of supply will always be a positive number. E S = % change in Q S % change in P Figure 4.7 illustrates the difference between an elastic and inelastic supply curve. With an inelastic supply curve such as S 1 , the quantity supplied is relatively insensitive to price changes and therefore will not change nearly as much as those goods/services that have an elastic supply curve such as S 2 . There are two major determining factors that govern whether a good or service is inelastic or elastic: § § availability of substitutes in production § § time horizon P ($) Q (#) Q * P * S PS Figure 4.6, Producer Surplus. At any market equilibrium price and quantity, producers would have been willing to sell some units at lower prices, as illustrated by the supply curve. Yet they will receive the higher market price. The area above the supply curve, but below the dashed line of the equilibrium price reflects what is called the producer’s surplus (shaded in orange). Producer’s surplus: the monetary gain to producers from the difference they would be willing to supply a good or service, and the market price. Elasticity of supply: a measure of the responsiveness of the quantity supplied to its price.