Producer Surplus & Economic Profit
Producer Surplus (PS)
Measures how much better off a firm is as a result of having supplied its profit-maximizing level
of output (see below**)
A firm's PS is not necessarily the same as economic profit
In the short run if the firm shuts down, they will sustain a loss of FC
If however, P > AVC
They can do better by supplying positive output and minimizing losses
(negative economic profit with losses less than FC)
How much better?
The firm's gain compared with the alternative of producing nothing is the difference between TR
and VC at the output level where P = MC
This is in fact PS (see above**)
PS = TR - VC
Profit = TR – TC
PS = TR – (TC – FC)
TC = VC + FC
VC = TC - FC
PS = TR – TC + FC
PS = Profit + FC
In the short run, PS is larger than economic profit, because the firm would lose more than its
economic profit if it were prevented from participating in the market.
*Notice that if FC = 0,
then PS = Profit