Lecture Notes: Economic Profits and Producer Surplus

Key Concepts

• Profitability

  • Firms must be profitable to survive or earn no less than zero economic profits.
  • Profits = Total Revenue - Total Cost.
  • Total Revenue: Money expected from selling products.
  • Total Cost: Includes both implicit and explicit costs.
    • Explicit Costs: Direct costs of production.
    • Implicit Costs: Opportunity costs, value of the best alternative use of resources.

• Zero Economic Profits

  • Earning zero profits means covering both implicit and explicit costs, making the effort worthwhile.
  • Positive economic profits imply earning more than the minimum required.

Consumer and Producer Surplus

• Consumer Surplus

  • When consumers pay less than their willingness to pay, resulting in surplus value (e.g., $5 saved on a $20 movie ticket).

• Producer Surplus

  • Value created through exchange for the producer.
  • Measured by the area above the supply curve and below the market price.
  • Represents marginal profit from each sale.
  • Total producer surplus is accumulated from all producers.

Supply Curve and Costs

• Supply Curve

  • Represents the marginal cost of production.
  • Total variable cost is the sum of marginal costs for units produced.
  • Total Revenue = Quantity Sold x Price.

• Producer Surplus Calculation

  • Subtract variable cost from total revenue.
  • Producer Surplus is different from profits; fixed costs also need to be subtracted for profits.

Example Calculation

• Market Supply Function: Qs = 4P - 50.

  • Market Price = $25.

• Steps to Calculate Producer Surplus

  1. Replace market price on graph with $25.
  2. Calculate quantity supplied at market price: Q = 50 units.
  3. Find y-intercept by setting Q = 0 to find the price: Price = $12.50.
  4. Calculate area of producer surplus triangle:
     • Base = 50 (from Q = 0 to Q = 50).
     • Height = 12.5 (from Price = 12.5 to Price = 25).
     • Area = 1/2 * Base * Height = 312.5.

• Example Profits Calculation

  • If fixed costs = $100, then total economic profit = $312.50 - $100 = $212.50.

Conclusion

• Producer Surplus represents excess benefit to the producer for each unit produced.
• Understanding economic profits and surpluses helps evaluate firm sustainability and market dynamics.