Economics Assignment1

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MBA Program - Managerial Economics - Group assignment

Hello all! The following are your group assignments that should be submitted up until January 24, 2021. You must
accompany each concept with numerical example!
Group one - Perfect Competition
1) Determinants of Price under Perfect Competition
COMPETITIVE EQUILIBRIUM
Perfect competition is commonly characterized by four conditions.
1. A large number of firms supply a good or service for a market consisting of
a large number of consumers.
2. There are no barriers with respect to new firms entering the market. As a
result, the typical competitive firm will earn a zero economic profit.
3. All firms produce and sell identical standardized products. Therefore, firms
compete only with respect to price. In addition, all consumers have
perfect information about competing prices. Thus, all goods must sell
at a single market price.
4. Firms and consumers are price takers. Each firm sells a small share of total
industry output, and, therefore, its actions have no impact on price.
Each firm takes the price as given—indeed, determined by supply and
demand. Similarly, each consumer is a price taker, having no
influence on the market price.
It is important to remember that these conditions characterize an ideal
model of perfect competition. Some competitive markets in the real world
meet the letter of all four conditions. Many other real-world markets are effectively perfectly competitive because
they approximate these conditions. At present, we will use the ideal model to make precise price and output
predictions
for perfectly competitive markets. Later in this and the following chapters, we
will compare the model to real-world markets.
In exploring the model of perfect competition, we first focus on the individual decision problem the typical firm
faces. Then we show how firm-level
decisions influence total industry output and price.

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2) The Irrelevance of Sunk Costs, Fixed Costs, and Average Costs
A sunk cost is an expense that already has been incurred and cannot be
recovered. For instance, in the earlier factory example, plant space originally may have been built at a high price. But
this historic cost is sunk and
is irrelevant to the firm’s current decision. As we observed earlier, in the
case of excess, unused factory capacity, the relevant opportunity cost is
near zero.
More generally, sunk costs cast their shadows in sequential investment decisions. Consider a firm that has spent $20
million in research and development
on a new product. The R&D effort to date has been a success, but an additional
$10 million is needed to complete a prototype product that (because of delays)
may not be first to market. Should the firm make the additional investment in
the product? The correct answer depends on whether the product’s expected
future revenue exceeds the total additional costs of developing and producing
the product. (Of course, the firm’s task is to forecast accurately these future revenues and costs.) The $20 million sum
spent to date is sunk and, therefore,
irrelevant for the firm’s decision. If the product’s future prospects are unfavorable, the firm should cease R&D.
Perhaps the last word on sunk cost is provided by the story of the seventeenthcentury warship Vassa. When newly
launched in Stockholm before a huge
crowd that included Swedish royalty, the ship floated momentarily, overturned,
and ignominiously (and literally) became a sunk cost.
232 Chapter 6 Cost Analysis
Business Behavior:
Sunk Costs
Sunk costs are easy to recognize in principle but frequently distort decisions
in practice. The construction of nuclear power plants in the 1970s and 1980s
illustrates the problem. New plant construction was plagued by cost overruns and safety problems. (Indeed, after the
Three Mile Island accident in
1979, safety concerns and strict safety regulations contributed to the overrun
problem.) At the same time, revenue projections declined due to the low
prices of alternative energy sources, oil and natural gas. While no new plants
were initiated in the 1980s (because of worsening profit prospects), many

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utilities continued to spend on plants already in progress, despite equally
dim profit predictions. In light of uncertain profits and looming losses, making the right decision—to continue
construction or abandon the effort—
wasn’t easy. (As the unrepentant actress Mae West once said, “In a choice
between two evils, my general rule is to pick the one I haven’t tried yet.”) In
some cases, utilities abandoned plants that were 85 percent complete after
having spent more than $1 billion. Yet looking forward, this might be a perfectly rational decision. By contrast,
construction of the Shoreham nuclear
plant on Long Island continued to completion despite severe cost escalation and safety concerns. With an accumulated
cost bill of $6 billion by 1989,
it never received regulatory approval to operate, and the enormous sums
spent came to nothing.
A sunk cost is an expense that already has been incurred and cannot be
recovered. For instance, in the earlier factory example, plant space originally may have been built at a high price. But
this historic cost is sunk and
is irrelevant to the firm’s current decision. As we observed earlier, in the
case of excess, unused factory capacity, the relevant opportunity cost is
near zero.
More generally, sunk costs cast their shadows in sequential investment decisions. Consider a firm that has spent $20
million in research and development
on a new product. The R&D effort to date has been a success, but an additional
$10 million is needed to complete a prototype product that (because of delays)
may not be first to market. Should the firm make the additional investment in
the product? The correct answer depends on whether the product’s expected
future revenue exceeds the total additional costs of developing and producing
the product. (Of course, the firm’s task is to forecast accurately these future revenues and costs.) The $20 million sum
spent to date is sunk and, therefore,
irrelevant for the firm’s decision. If the product’s future prospects are unfavorable, the firm should cease R&D.
Perhaps the last word on sunk cost is provided by the story of the seventeenthcentury warship Vassa. When newly
launched in Stockholm before a huge
crowd that included Swedish royalty, the ship floated momentarily, overturned,
and ignominiously (and literally) became a sunk cost.
232 Chapter 6 Cost Analysis

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Business Behavior:
Sunk Costs
Sunk costs are easy to recognize in principle but frequently distort decisions
in practice. The construction of nuclear power plants in the 1970s and 1980s
illustrates the problem. New plant construction was plagued by cost overruns and safety problems. (Indeed, after the
Three Mile Island accident in
1979, safety concerns and strict safety regulations contributed to the overrun
problem.) At the same time, revenue projections declined due to the low
prices of alternative energy sources, oil and natural gas. While no new plants
were initiated in the 1980s (because of worsening profit prospects), many
utilities continued to spend on plants already in progress, despite equally
dim profit predictions. In light of uncertain profits and looming losses, making the right decision—to continue
construction or abandon the effort—
wasn’t easy. (As the unrepentant actress Mae West once said, “In a choice
between two evils, my general rule is to pick the one I haven’t tried yet.”) In
some cases, utilities abandoned plants that were 85 percent complete after
having spent more than $1 billion. Yet looking forward, this might be a perfectly rational decision. By contrast,
construction of the Shoreham nuclear
plant on Long Island continued to completion despite severe cost escalation and safety concerns. With an accumulated
cost bill of $6 billion by 1989,
it never received regulatory approval to operate, and the enormous sums
spent came to nothing.
3) Producer Surplus and Profit in Short-Run Competitive Equilibrium
Updated October 7, 2020
What is a Producer Surplus?

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DEFINITION:
Producer surplus is the amount of money a producer receives from selling goods that is above the
minimum amount they were willing to accept for them.
🤔 Understanding producer surplus

Producer surplus refers to the gain a seller gets from a sale - the amount of money they receive in excess of
the minimum price at which they would sell the item. It’s a producer’s revenue minus their direct costs of
production minus their opportunity costs, or the cost of foregoing the value another use of their resources
might bring. It’s a way of considering the workings of a free market in which both producers and consumers
benefit. For a transaction to be successful, the price must fall between the minimum the seller will accept,
and the maximum the buyer will pay. Consequently, the seller receives more than their lowest acceptable
price (producer surplus), and the buyer gets the item for less than they were willing to pay (consumer
surplus).
EXAMPLE
Suppose Tom has an old car he wants to sell. He would accept anything over $2,500 for it. If he can’t get at
least that much, he would rather give it to his niece for her birthday than let a stranger have it that cheaply.
When a buyer comes along, he ends up selling the car for $2,750. That’s $250 more than his minimum, and
that $250 is his producer surplus.
Takeaway
Producer surplus is like getting a raise you didn’t ask for at work…
When you work, you agree to sell an hour of your time for a certain amount of money - your salary. Your
paycheck is what you expect to get, the minimum you’re willing to accept for the work you do. Imagine that
one day when you clock out and you get your paycheck, it’s $100 more than you expected, and there’s a
note from your boss that says, “I’m giving you a raise because of all your hard work!” The raise means you’re
getting more money than the minimum you required to show up. You’re getting paid more, and that’s
similar to producer surplus.
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 What is a producer surplus?
 Why is producer surplus important?
 What is the difference between a producer surplus and a consumer surplus?
 What is the difference between a producer surplus and profit?
 How is producer surplus measured?
 Is producer surplus good or bad?
 How do you maximize producer surplus?
What is a producer surplus?

Producer surplus describes the benefit that a seller gets when they make a sale. If the seller is willing to
accept no less than $100 for their product, anything above $100 is producer surplus. A seller must cover all
of their direct costs of producing the item, plus their opportunity costs (the costs of foregoing the value of
another way they might have used their resources), to break even. Anything above that breakeven price
would be a producer surplus. The sum of producer surpluses from all sales must cover a business’s fixed
costs for them to make a profit.
Why is producer surplus important?

Producer surplus is the incentive for an entrepreneur to risk their time, money, and energy in a business
pursuit. Without producer surplus, there would be no reward for innovation. Capitalism and a free-market
economy are based on business owners reaping benefits by bringing products to customers that want them.
What is the difference between a producer surplus and a consumer

surplus?
In a voluntary trade, everyone wins; if they didn’t, they’d simply walk away and not make the deal. A trade
that improves everyone's position is said to generate an economic surplus, which is shared between the
seller and the buyer. The seller’s gains are called producer surplus, and the buyer’s gains are consumer
surplus.
Imagine the owner of an old book wants to sell it. The owner gets some value from keeping it; maybe they’ll
reread it someday. That implies there is a minimum price the owner needs to receive in order to be
prompted to sell it, representing whatever amount they place on the joy of owning it. Assume that value is
$5.
Now consider a potential buyer for the book. Other copies of the book are available online for $10, and the
buyer is willing to pay that much for the copy the owner has. Because the buyer is willing to pay more than
the minimum price the seller needs, a transaction is possible, and there are $5 in potential economic gains
that can be split between them (the buyer’s maximum of $10 minus the seller’s minimum of $5).
That $5 will become consumer and producer surplus, divided between the buyer and seller depending on
what price they agree on. For instance, if they agree to a $6 sales price, the buyer gets $4 of consumer
surplus (the buyer’s $10 maximum minus $6), while the seller gets $1 of producer surplus (the $6 sales price
minus the seller’s $5 minimum, which covers the loss of value from no longer owning the book).
What is the difference between a producer surplus and profit?

Profit is total revenues minus total costs. Conversely, producer surplus is the revenue from the sale of one
item minus the marginal, direct cost of producing that item - i.e., the increase in total cost caused by that
item. If a business’s only costs are marginal, direct costs, then profit and producer surplus are the same. But
if there are fixed or sunk costs - costs like rent or new equipment that don’t change no matter how much or
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little you produce - those costs are factored into the calculation of profit, and profit is less than producer
surplus.
Assume you buy a $10,000 machine that makes picture frames. You sell these picture frames for $10 each.
The materials and direct labor required to make each picture frame is $6. On each sale, you earn $4 of
producer surplus. But it would be wrong to say that you made $4 in profit after your first sale. In reality,
you’re still $9,996 in the hole. Until you sell your 2,500th picture frame, you haven’t recovered the machine’s
cost. Every sale after that point contributes to your profit.
In accounting, the cost of that machine gets spread over time or production units. Assume the expected life
of the machine is 5,000 picture frames. After that, it must be replaced. In that case, you can allocate the
initial cost of the machine to each picture frame it makes. To do so, you would depreciate (reduce the asset
value of the machine) by $2 per picture frame, or the $10,000 cost of the machine divided by 5,000 frames.
Subtracting the depreciation from the producer surplus generates net income, a measure of profit.
How is producer surplus measured?

Producer surplus is the sales price minus the minimum price a seller would accept. In business, that
minimum price is the marginal cost of production, or the cost of creating or acquiring an item, including any
marginal opportunity costs. A company might sell a product below that cost for specific reasons, but they
would go out of business if that happened too often.
Therefore, the formula to calculate a producer's surplus is:
Producer surplus = Revenue – Marginal cost
Plotting the marginal cost of production on a graph produces a supply curve. The area under the supply
curve represents the direct costs of production. The area above the supply curve represents the net benefit
to the seller, or producer surplus.
Plotting the sales price on the same graph allows you to visualize where that producer surplus is, and how to
measure it. The sales price and the number of units sold form a rectangle on the graph, representing total
sales revenue. The supply curve bisects that rectangle to form two triangles. The triangle below the supply
curve represents the marginal costs; the one above the supply curve represents the producer surplus.
As long as the supply curve is linear, with marginal costs increasing by the same amount for each unit, the
math is easy. The producer surplus is the area of the upper triangle - the base times the height of the
triangle, divided by 2. (The calculation for nonlinear supply curves is more complex.)
Mathematically, it is the total revenue minus the sum of marginal costs for each unit:
Total producer surplus = Total revenue – Sum of marginal costs
Imagine Sally selling seashells by the seashore for $5 each. And assume her marginal cost of acquiring these
seashells increases by $0.25 for every seashell she collects. Given that supply curve, Sally should stop
retrieving seashells when she gets to 20 shells, because the marginal cost would then hit $5. ($0.25 x 20 =
$5.)
That means her producer surplus equals $5, the height of the upper triangle, times 20 shells, the base,
divided by 2 - or $50. (See the accompanying graph.) We can also calculate producer surplus by using the
formula above First, her total revenue is $5 times 20 shells, or $100.
Marginal costs are the size of the triangle below the supply curve, using the same method of height of $5
times base of 20 shells divided by 2:
Sum of marginal costs = ($5 x 20 shells) / 2 = $50
So, using the producer surplus formula.
Producer surplus = $100 revenue - $50 costs = $50
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Of course, Sally should make sure there are at least 20 people willing to pay $5. To do that, she needs to
understand the demand curve for her product. If there are exactly 20 people willing to pay $5, that would be
considered the equilibrium price.
Is producer surplus good or bad?

A producer surplus is good for the seller. It is what encourages the seller to be in business. And, if any
producer surplus exists, it implies that there is also some consumer surplus (benefit to a buyer) on the other
side of the transaction.
However, the negotiations over the price of a transaction are a zero-sum game - when one person gains, the
other loses. Any increase in producer surplus results in a decrease in consumer surplus. Therefore, from the
buyer’s perspective, an increase in producer surplus is a bad thing. It implies a higher price, which means the
buyer pays more.
How do you maximize producer surplus?

The maximum amount of producer surplus that is possible would occur if a seller could get a buyer to pay
their maximum price. If so, the seller would capture all the potential gains from a transaction. A business that
sells to many buyers would maximize producer surplus if it could capture the maximum price that each
consumer is willing to pay, an outcome known as perfect price discrimination. In most situations, that is hard
to do.
Instead, sellers in a competitive market post one price that all buyers are willing to pay. But there are some
ways to charge different prices to different groups of people — which would increase producer surplus.
Offering coupons or senior discounts are examples of this. Using auctions can also get different people to
pay different prices.
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Consumer Surplus and Producer Surplus

Economic terms used to determine market wellness by studying the relationship between the consumers
and suppliers
Home › Resources › Knowledge › Economics › Consumer Surplus and Producer Surplus
What are Consumer Surplus and Producer Surplus?

Both consumer surplus and producer surplus are economic terms used to define market wellness by studying the
relationship between the consumers and suppliers. They explain the opportunity cost consumers forego to gain
a marginal benefit for buying a good or service. To the producer, it is the willingness and ability to produce an
extra unit of a product based on the marginal cost of producing more goods.

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Summary
 Both consumer surplus and producer surplus are economic terms used to define market wellness by studying
the relationship between the consumers and suppliers.
 The consumer surplus refers to the difference between what a consumer is willing to pay and what they paid
for a product.
 The producer surplus is the difference between the market price and the lowest price a producer is willing to
accept to produce a good.
Understanding Consumer Surplus and Producer Surplus
When discussing consumer and producer surplus, it is important to understand some base concepts used by
economists to explain the inter-relationship.
Both consumer and producer surplus can be graphed to display either a demand curve or marginal benefit curve
(MB) and a supply curve or marginal cost curve (MC).

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Consumer surplus refers to the monetary gain enjoyed when a purchaser buys a product for less than what they
normally would be willing to pay. Each corresponding product unit price along the supply curve is known as
the marginal cost (MC).

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On the other hand, the producer surplus is the price difference between the lowest cost to supply the market
versus the actual price consumers are willing to pay. The price of a product unit along the supply curve is
known as the marginal cost (MC).
When graphing consumer surplus, the area above every extra unit of consumption, is referred to as the total
consumer surplus. Similarly, the area above the supply curve for every extra unit brought to the market is
referred to as the total producer surplus.
When you add both the consumer and producer surplus, you get the total surplus, also known as total welfare or
community surplus. It is used to determine the well-being of the market. When all factors are constant, in a
perfect market state, an equilibrium is achieved. This state is also referred to as allocative efficiency – the
marginal cost and marginal benefit are equal.

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Understanding Consumer Surplus
To fully conceptualize consumer surplus, take an example of a demand curve of chocolates plotted on a graph.
The unit price is plotted on the Y-axis and the actual chocolate units of demand per day on the X units. The
graph below shows the consumer surplus when consumers purchase two units of chocolates.

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Calculating the Total Consumer Surplus

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To calculate consumer surplus, account for Δ0 units. In the graph above, the corresponding unit price is $14. It
is the market price that consumers are able and willing to purchase a bar of chocolate.
Since the demand curve is linear, the shape formed between Δ0 unit to 2 and below the demand curve is
triangular. Therefore, the ordinary formula for finding an area of a triangle is used. The unit items cancel out to
leave the result expressed in monetary form.
Total Consumer Surplus Formula

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Where:
 Qn = Quantity of demand/supply either at equilibrium or the willing purchasing or selling price
 ΔP = The difference between the price at equilibrium or at the purchasing or selling point and the price at Δ0
In summation, the market saves $3 for the same unit it could’ve purchased for $14.
Understanding Producer Surplus
Using the same example with all the X and Y-axis numbers, the producer surplus is calculated using the same
formula. Below is the graph for the illustration:

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Calculating the Total Producer Surplus

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The producer surplus cost at two units is $4 ($6 – $2). This means that the supplier(s) will forego $4 per unit for
producing two units.
Total Surplus
In the previous example, the total consumer surplus was $3, and the total producer surplus $4, respectively. The
total surplus, therefore, will be $7 ($3 + $4). Below is the formula:
Total Surplus = Consumer Surplus + Producer Surplus

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In the above example, the total surplus does not depict the equilibrium. There is a deadweight to shed off.
Supplier overheads are higher for producing two units. Similarly, the consumer is getting less than what the
market can offer.
As a result, to achieve a stable market, the producer(s) must increase the production to reduce the deadweight
and attain the equilibrium. At the equilibrium, the consumer(s) will enjoy the highest marginal utility, and
supplier(s) will maximize profits.
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4) Welfare properties of perfectly competitive markets
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Welfare Maximisation and Perfect Competition (With Diagram)
Article Shared by
ADVERTISEMENTS:
Under certain assumptions an economy can reach the point of maximum social welfare.
It should be stressed that the bliss point (and the solution of the system for the values of the
ten variables that are the unknowns in the welfare-maximisation problem of the 2 x 2 x 2
model) depends only on technological relations the problem of welfare maximisation is purely
‘technocratic’.
Recall that the bliss point is attained by equalising the slopes of isoquants, the slopes of the
indifference curves, and the slope of the production possibility curve to the (equalized) slope
of the indifference curves. Thus, the welfare-maximising solution does not depend on prices.
ADVERTISEMENTS:
Perfect competition can lead to a general equilibrium situation where the three marginal
conditions of Pareto optimality are satisfied.
(a) Profit maximisation by the individual firm implies that whatever output the firm may
choose as the most profitable must be produced at a minimum cost. Cost minimisation is
attained if the firm chooses the input combination at which the marginal rate of technical
substitution of the two factors is equal to the input price ratio.
MRTSL,k = w/r
Since in perfect competition all firms are faced by the same set of factor prices, it follows that
ADVERTISEMENTS:
MRTSxL,K = MRTSyL,K = w/r

Thus in figure 23.8 the slope of the contract curve at W'” must be equal to w/r in perfectly
competitive input markets, since W'” is the point of the (equalised) slope of the isoquants Y*
and X*.
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(b) Utility maximisation by each individual requires the choice of the product-mix where the
marginal rate of substitution of the two commodities is equal to the ratio of their price
MRSx,y = Px/Py
ADVERTISEMENTS:
Since in perfect competition all consumers are faced by the same commodity prices, it follows
that
MRSAx,y = MRSBx,y = Px/Py

Thus in figure 23.7 the slope of the contract curve at W” must be equal to the P x/Py ratio in
perfectly competitive commodity markets, since W” is the point of the (equalised) slope of the
indifference curves of the two consumers.
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(c) We have shown that at the bliss point the (equalised) slope of the indifference curves (the
‘common’ MRSx,y) is equal to the slope of the production possibility curve at W”. Thus at W”,
which defines the product-mix that maximises social welfare, we have
MRPTx,y = Px/Py
(d) Finally, a firm in a perfectly competitive market maximises its profit by setting its
marginal cost equal to the market price of the commodity. Consequently we have
MRPTx,y = Px/Py = MCx/MCy
Thus we have established that a perfectly competitive system guarantees the attainment of
maximum social welfare. This is the result of the maximising behaviour of firms and
consumers. In a perfectly competitive (free enterprise) system, each individual, in pursuing
his own self-interest, is led by an ‘invisible hand’ to a course of action that increases the
general welfare of all.
However, perfect competition is only one way for attaining welfare maximisation. A
decentralised socialist system, for example, in which the government has somehow estimated
‘shadow’ prices and directs its individual economic units to maximise their ‘gains’, can in
principle achieve the same results as a perfectly competitive system.
In summary, Implicit in the purely ‘technocratic’ problem of welfare maximisation is a set of

‘prices’. Decentralised decisions in response to these ‘prices’ by atomistic profit maximisers
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and utility maximisers will result in just that levels of inputs, outputs and commodity-
distribution that the bliss point requires.
The individual maximisers can be acting in a perfectly competitive system, or in a

decentralised social system of the Lerner-Lange type, where bureaucrats have established
somehow the ‘prices’ that maximise social welfare and coerce the citizens to act in response to
these ‘prices’.
ADVERTISEMENTS:
The above ‘duality theorem’ is the kernel of modern welfare economics. This ‘duality theorem’
may be stated as follows. Welfare maximisation can be attained by maximising behaviour of
individuals, given the technological relations of the production function, ordinal indexes of
the utility of consumers, and given a social welfare function. The welfare maximisation is
independent of prices.
However, implicit in the logic of this purely technocratic formulation is a set of constants.
These constants can be the prices of a perfectly competitive economy, or the ‘shadow prices’ of
a socialist economy. Thus, if these ‘prices’ (constants) are known (as, for example, the prices
of a perfectly competitive system), and individual profit maximisers and utility maximisers
act in response to these prices, their behaviour will lead to the maximisation of social welfare.
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Characteristics: Perfectly Competitive Market | Economy
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The following points highlight the top seven characteristics of a perfectly

competitive market. The characteristics are: 1. Large Number of Buyers and
Sellers 2. Homogeneous Product 3. Perfect Knowledge about the
Market 4. Free Entry and Free Exit 5. Mobility of the Factors 6. Production
Cost is the Only Cost 7. Horizontal Shape of the Firm’s Average and Marginal
Revenue Curves.
Characteristic # 1. Large Number of Buyers and Sellers:
In a perfectly competitive market, the number of buyers and sellers should be large. However,
there is no hard and fast rule about how ‘large’ the number should be. But the number
should be so large that each buyer buys, on average, a negligibly small fraction of the total
quantity bought and sold in the market and each seller also, on an average, sells a negligibly
small fraction.
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The significance of this assumption is this. If each buyer buys a small fraction of the total
quantity bought and sold, then he would not be able to exercise an individual influence on the
process of determination of the market price of the product.
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For, if he wants to buy at a smaller price than what the market determines and if he refuses to
buy unless the price is lowered, the market demand for the good would not be affected
because, in any case, he buys a small fraction, and so the market price also would not be
affected by his individual efforts.
However, if the number of buyers had been so small that each buyer was in a position to buy a
sizeable amount of the total quantity and if, in that case, a buyer refused to buy the good
unless the price was lowered, demand for the good would have fallen considerably, resulting
in a fall in the price. That is, in this case, the buyer could have influenced price determination
and could achieve a lower price by his individual efforts.
It follows from above that if the number of buyers is large, then no buyer would be able to
influence the determination of market price in his favour. He would have to accept the price of
the product as given, i.e., he would have to behave as a price-taker. This is the implication of
the assumption that there should be a large number of buyers in a perfectly competitive
market.
Similarly, if each seller sells a small fraction of the total quantity sold, then no seller would be
able to influence the determination of market price of the product. For, if any seller charges a
higher price and refuses to sell if he cannot have this, then the total supply of the product
would not be reduced appreciably, because in any case he sells a very small quantity.
Consequently, the price of the product would not rise.
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However, if there were a few sellers of the product, then each seller would have sold a sizable
proportion of the total product. In that case, if any seller wanted to charge a higher price and
withdrew his supply unless allowed to do so, the total supply would reduce appreciably and
the price of the product would rise.
It is clear, therefore, that if the number of sellers is large, none of them can have any
individual influence on the process of price determination. That is, like the buyers, the sellers
also take the price of the product as given. They are price-takers.
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Characteristic # 2. Homogeneous Product:
It is assumed that in a perfectly competitive market, the firms produce and sell a
homogeneous product. In other words, in a competitive market, the buyers do not
discriminate between the sellers. They accept the products of all the sellers as homogenous or
identical.
Because of this assumption, the buyers do not show preference for any particular seller(s). To
them all the sellers appear to be equally preferred. That is why it is said that in a perfectly
competitive market, the sellers sell not only a homogeneous product, they also sell an
identical behaviour.
Characteristic # 3. Perfect Knowledge about the Market:

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It is assumed that in a perfectly competitive market, the buyers and sellers possess perfect
knowledge about the conditions prevailing in the market. This assumption has been made
because, if the buyers do not have the knowledge about the price of the product or about the
sellers of the product, then some sellers may take this opportunity to charge a higher price for
their products.
Consequently, the market would experience the circumstances where some sellers are taking
relatively larger prices, and some are taking relatively smaller prices. In that case, there would
be nothing like a ‘particular’ market price of the product. This is not compatible with the
concept of perfect competition.
The sellers should also have perfect knowledge about market conditions. Otherwise some of
them would sell the product at a lower or higher price than others. In that case also, a unique
market price would not prevail in the market.
Characteristic # 4. Free Entry and Free Exit:

Another characteristic feature which is assumed to be present in a perfectly competitive
market is that of free entry and free exit. This means that any new firm may enter the market
for the product, i.e., it may participate in the production and sale of the good. Also, any
existing firm may leave the industry or the market. However, free entry and free exit would be
possible only in the long run.
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For, a firm that intends to enter the market would have to acquire the fixed inputs, which is
not possible in the short run. On the other hand, the firm that has decided to leave the
industry would have to wait till it is able to dispose of its fixed inputs, and this would require a
long run.
The assumption of free entry and free exit implies that, if in the short run, the firms are in a
position to earn more than the normal profit, then in the long run, the number of firms in the
industry would increase, and, consequently, the supply of the product would be increasing,
price would be falling, and, in the long run (ultimately), the firms would be able to earn only
the normal profit.
On the other hand, if, in the short run, existing firms are not able to earn even the normal
profit, i.e., if they happen to suffer losses, then, in the long run, the firms would be leaving the
industry.
Consequently, the supply of the product would be falling, and price would be rising till the still
existing firms may again rise to a position of earning the normal profit. Therefore, owing to
this characteristic feature of free entry and free exit, the firms under perfect competition
would be able to earn only the normal profit in the long run.
Characteristic # 5. Mobility of the Factors:

Next, it is assumed that the factors of production that the firms use are homogeneous and
perfectly mobile, The implication Of this assumption is that if the factors are homogeneous
and perfectly mobile, then their prices would be the same to all firms. For if they are given
lower prices by an employer, they would leave that place and join some other firm where they
would get higher prices.
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As a result, supply of factors to the first firm would decrease and that to the second firm would
increase. Consequently, the prices of the factors would go up in the former and those would
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come down in the latter. If the process goes on, ultimately all the firms would have to buy all
the factors at the same prices. In that case, competition between the firms would be perfect.
Characteristic # 6. Production Cost is the Only Cost:

Lastly, it is assumed that the competitive firms bear only the production cost and they do not
have to bear costs like those of transport and advertisement. That the firms here are not
required to bear the advertisement cost is obvious from characteristics (ii) and (iii).
According to these two characteristic features, the buyers are perfectly aware of homogeneity
and uniqueness of the price of the product that the firms produce. And the firms also are
aware that they would not be able to influence the buyers in favour of their respective
products by means of advertisement.
What this assumption seeks to imply is that the firms are not required to bear any cost like
advertisement or transport that may vary between the firms even if they are equally efficient.
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In other words, this assumption implies that if the firms are equally efficient, then their total
cost should be the same at any particular quantity of output, and if, by total cost we mean only
production cost, then this property is easily obtained. It may be noted that this property is
consistent with the concept of competition among the equals.
Characteristic # 7. Horizontal Shape of the Firm’s Average and Marginal

Revenue Curves:
This property states that at a time there would be obtained only one price of the product in the
perfectly competitive market and the average and marginal revenue (AR and MR) curves of
each firm here would be identical and both of them would be the same horizontal straight line
at the level of the price of the product.
The price of the product would be determined in the process of interaction between demand
and supply for the product.
The reason for the AR and MR curves of the competitive firm to be an identical horizontal
straight line may be given like this. As we know from characteristic feature (i) of large number
of sellers that each seller under perfect competition is a price-taker.
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Also we know from characteristic feature (iii) of perfect knowledge of the buyers that, if any
seller refuses to be a price-taker and charges more than the ruling market price, then he
would find no customers. For they are perfectly aware of the fact that a homogeneous product
[characteristic feature (ii)] was being sold in the market by a large number of sellers.
Again, since the number of sellers is large in the market, each seller thinks that he is supplying
a very small fraction of the total quantity demanded and supplied in the market and so the
total quantity demanded of the product is much more than what he supplies.
Therefore, if he wants to sell more he would not have to worry about demand, i.e., he would
not have to reduce the price to sell more. In other words, he thinks that he might sell more at
the same price.
It is clear from the above discussion that the firm under perfect competition would not charge
more than the ruling market price, for then he would not find any customer, nor would he
charge a lower price because he can sell more, if he liked, at the same price. It follows then
that a single price would rule the market at a time, and the firm thinks that he would be able
to sell any quantity, more or less, at the ruling price.
Therefore, in this market we would obtain p = AR = constant at any q (quantity sold), and so
we would also obtain MR = AR at any q. That is, the AR and MR curves of a firm under perfect
competition would be identical, and it would be the horizontal straight line at the level of p.
It may be noted here that since the firm’s AR curve or the demand curve (for the firm’s
product) is a horizontal straight line, the firm’s quantity demanded can change even without
any change in price. Therefore, at any point on this demand curve, the numerical coefficient
(e) of price-elasticity of demand will be infinitely large (e = ∞).
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Welfare Implications of a Perfectly Competitive Market |
Economics
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In this article we will discuss about the welfare implications of a perfectly competitive market.
Favourable Features of a Perfectly Competitive Price System:

Such a perfectly competition system yields certain beneficial consequences in long-run
equilibrium.
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They are listed below:
1. Consumer preferences as reflected in the market-place would be fulfilled. Here P=MC=MU.
So, both consumers and producers are satisfied.
2. Society’s resources would be allocated in the most efficient way, both within and between
industries.
3. Flexible factor and product prices would ensure full employment of all factors of
production.
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4. Competition among employers for inputs and among factors for jobs would cause factor
owners to be paid their opportunity costs; these would be determined by the respective
contributions to total output of each factor, as measured by its marginal product.
5. With consumer incomes and tastes given, aggregate consumer satisfaction would be
maximised because goods would be distributed among consumers according to their
demands.
Perfect Competition as an Efficient Allocator of Resources:

There are certain welfare implications of perfect competition. It may be argued that an
economy consisting entirely of perfectly competitive markets leads to a maximisation of
consumer satisfaction. This follows because, in long-run equilibrium, competition forces firms
to produce with the least- cost technology available, at the lowest possible average per unit
cost, and sell to consumers at a price that just covers this cost.
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In addition, P=MC balance implies that consumers pay a price that just covers the cost of the
last unit of each kind of good produced. Because of the ease of entry and exit of firms to and
from industries, a perfectly competitive economy will quickly re-allocated resources to meet
changing consumer preferences or reflect changing supply conditions. Hence, resources are
always efficiently allocated in accordance with consumers’ tastes.
Criticisms of Perfect Competition:

There are several reservations about whether perfect competition will assure maximum
consumer satisfaction; it is felt that it provides little incentive for technological innovation;
spill-over costs and benefits are not captured; there is a lack of product variety; and income
distribution may not be ‘equitable’.
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Group Two - Monopoly

 Monopoly and the Price Elasticity of Demand
 Regulating Price under Natural Monopoly
 Welfare Effects of Monopoly
Group Three - Monopolistic Competition
 Characteristics of Monopolistic Competition
 Short-run Monopolistically Competitive Equilibrium
 Long-run Monopolistically Competitive Equilibrium
 Advertising in monopolistically competitive industries
Group Four - Duopoly and Oligopoly
 Characteristics of Duopoly and Oligopoly
 Measuring Industrial Concentration
 Models of Duopoly and Oligopoly
Group Five - Demand forecasting
 Nature of seasonal demand products
 Techniques of Demand forecasting for seasonal period demands
Group Six - Demand forecasting
 Nature of trend demand products
 Forecasting techniques for trend demand patterns.
Group seven - The National Income and Open Economy
 National Income Accounting
 Aggregate demand and supply
Group eight - Capital Budgeting
 Investment under Certainty
 Investment under uncertainty
Group nine: decision theory
 Decision making under risk
 Decision making under uncertainty
Group Ten: Demand, Supply, and Market Equilibrium
 The general Demand functions
 Direct Demand Functions
 Inverse Demand Functions
 Shifts in demand
Group eleven: Supply
 The General Supply Function
 Direct Supply Functions
 Inverse Supply Functions
 Shifts in Supply
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Group Twelve: Market Equilibrium
 Describe Market Equilibrium
 Consumer Surplus
 Producer Surplus
 Social Surplus
 Changes in Demand (Supply Constant)
 Changes in Supply (Demand Constant)
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Boundless Economics
Competitive Markets
Perfect Competition
Definition of Perfect Competition
Perfect competition is a market structure that leads to the Pareto-efficient allocation of economic
resources.
LEARNING OBJECTIVES
Describe degrees of competition in different market structures
KEY TAKEAWAYS
Key Points
 The major types of market structure include monopoly, monopolistic competition, oligopoly,
and perfect competition.
 Perfect competition is an industry structure in which there are many firms producing
homogeneous products. None of the firms are large enough to influence the industry.
 The characteristics of a perfectly competitive market include insignificant contributions from
the producers, homogenous products, perfect information about products, no transaction
costs, and no long-term economic profits.
 In practice, very few industries can be described as perfectly competitive, though agriculture
comes close.
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Key Terms
 monopoly: A situation, by legal privilege or other agreement, in which solely one party
(company, cartel etc. ) exclusively provides a particular product or service, dominating that
market and generally exerting powerful control over it.
 Monopolistic competition: A market structure in which there is a large number of firms,
each having a small proportion of the market share and slightly differentiated products.
 oligopoly: An economic condition in which a small number of sellers exert control over the
market of a commodity.
Market structure is determined by the number and size distribution of firms in a market, entry
conditions, and the extent of product differentiation. The major types of market structure include the
following:
 Monopoly: An industry structure where a single firm produces a product for which there are no
close substitutes. Monopolists are price makers. Barriers to entry and exit exist, and, in order to
ensure profits, a monopoly will attempt to maintain them.
 Monopolistic competition: A market structure in which there is a large number of firms, each
having a small portion of the market share and slightly differentiated products. There are close
substitutes for the product of any given firm, so competitors have slight control over price. There
are relatively insignificant barriers to entry or exit, and success invites new competitors into the
industry.
 Oligopoly: An industry structure in which there are a few firms producing products that range
from slightly differentiated to highly differentiated. Each firm is large enough to influence the
industry. Barriers to entry exist.
 Perfect competition: An industry structure in which there are many firms, none large enough to
influence the industry, producing homogeneous products. Firms are price takers. There are no
barriers to entry. Agriculture comes close to being perfectly competitive.
Perfect competition leads to the Pareto-efficient allocation of economic resources. Because of this it
serves as a natural benchmark against which to contrast other market structures. However, in
practice, very few industries can be described as perfectly competitive. Nevertheless, it is used
because it provides important insights.
A perfectly competitive market has several important characteristics:
 All producers contribute insignificantly to the market. Their own production levels do not change
the supply curve.
 All producers are price takers. They cannot influence the market. If a firm tries to raise its price
consumers would buy from a competitor with a lower price instead.
 Products are homogeneous. The characteristics of a good or service do not vary between
suppliers.
 Producers enter and exit the market freely.
 Both buyers and sellers have perfect information about the price, utility, quality, and production
methods of products.
 There are no transaction costs. Buyers and sellers do not incur costs in making an exchange of
goods in a perfectly competitive market.
 Producers earn zero economic profits in the long run.
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Conditions of Perfect Competition
A firm in a perfectly competitive market may generate a profit in the short-run, but in the long-run it
will have economic profits of zero.
LEARNING OBJECTIVES
Calculate total revenue, average revenue, and marginal revenue for a firm in a perfectly competitive market
KEY TAKEAWAYS
Key Points
 A perfectly competitive market is characterized by many buyers and sellers, undifferentiated

products, no transaction costs, no barriers to entry and exit, and perfect information about the
price of a good.
 The total revenue for a firm in a perfectly competitive market is the product of price and
quantity (TR = P * Q). The average revenue is calculated by dividing total revenue by
quantity. Marginal revenue is calculated by dividing the change in total revenue by change in
quantity.
 A firm in a competitive market tries to maximize profits. In the short-run, it is possible for a
firm’s economic profits to be positive, negative, or zero. Economic profits will be zero in the
long-run.
 In the short-run, if a firm has a negative economic profit, it should continue to operate if its
price exceeds its average variable cost. It should shut down if its price is below its average
variable cost.
Key Terms
 economic profit: The difference between the total revenue received by the firm from its sales
and the total opportunity costs of all the resources used by the firm.
The concept of perfect competition applies when there are many producers and consumers in the
market and no single company can influence the pricing. A perfectly competitive market has the
following characteristics:
 There are many buyers and sellers in the market.

 Each company makes a similar product.
 Buyers and sellers have access to perfect information about price.
 There are no transaction costs.
 There are no barriers to entry into or exit from the market.
All goods in a perfectly competitive market are considered perfect substitutes, and the demand curve
is perfectly elastic for each of the small, individual firms that participate in the market. These firms are
price takers–if one firm tries to raise its price, there would be no demand for that firm’s product.
Consumers would buy from another firm at a lower price instead.
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Firm Revenues
A firm in a competitive market wants to maximize profits just like any other firm. The profit is the
difference between a firm’s total revenue and its total cost. For a firm operating in a perfectly
competitive market, the revenue is calculated as follows:
 Total Revenue = Price * Quantity

 AR (Average Revenue) = Total Revenue / Quantity
 MR (Marginal Revenue) = Change in Total Revenue / Change in Quantity
The average revenue (AR) is the amount of revenue a firm receives for each unit of output. The
marginal revenue (MR) is the change in total revenue from an additional unit of output sold. For all
firms in a competitive market, both AR and MR will be equal to the price.
Profit Maximization
In order to maximize profits in a perfectly competitive market, firms set marginal revenue equal to
marginal cost (MR=MC). MR is the slope of the revenue curve, which is also equal to the demand
curve (D) and price (P). In the short-term, it is possible for economic profits to be positive, zero, or
negative. When price is greater than average total cost, the firm is making a profit. When price is less
than average total cost, the firm is making a loss in the market.
Perfect Competition in the Short Run: In the short run, it is possible for an individual firm to make an economic profit. This
scenario is shown in this diagram, as the price or average revenue, denoted by P, is above the average cost denoted by C.
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Over the long-run, if firms in a perfectly competitive market are earning positive economic profits,
more firms will enter the market, which will shift the supply curve to the right. As the supply curve
shifts to the right, the equilibrium price will go down. As the price goes down, economic profits will
decrease until they become zero.
When price is less than average total cost, firms are making a loss. Over the long-run, if firms in a
perfectly competitive market are earning negative economic profits, more firms will leave the market,
which will shift the supply curve left. As the supply curve shifts left, the price will go up. As the price
goes up, economic profits will increase until they become zero.
In sum, in the long-run, companies that are engaged in a perfectly competitive market earn zero
economic profits. The long-run equilibrium point for a perfectly competitive market occurs where the
demand curve (price) intersects the marginal cost (MC) curve and the minimum point of the average
cost (AC) curve.
Perfect Competition in the Long Run: In the long-run, economic profit cannot be sustained. The arrival of new firms in the
market causes the demand curve of each individual firm to shift downward, bringing down the price, the average revenue and
marginal revenue curve. In the long-run, the firm will make zero economic profit. Its horizontal demand curve will touch its
average total cost curve at its lowest point.
The Demand Curve in Perfect Competition
A perfectly competitive firm faces a demand curve is a horizontal line equal to the equilibrium price of
the entire market.
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LEARNING OBJECTIVES
Describe the demand for goods in perfectly competitive markets
KEY TAKEAWAYS
Key Points
 In a perfectly competitive market individual firms are price takers. The price is determined by
the intersection of the market supply and demand curves.
 The demand curve for an individual firm is different from a market demand curve. The market
demand curve slopes downward, while the firm’s demand curve is a horizontal line.
 The firm’s horizontal demand curve indicates a price elasticity of demand that is perfectly
elastic.
Key Terms
 Perfectly elastic: Describes a situation when any increase in the price, no matter how small,
will cause demand for a good to drop to zero.
In a perfectly competitive market the market demand curve is a downward sloping line, reflecting the
fact that as the price of an ordinary good increases, the quantity demanded of that good decreases.
Price is determined by the intersection of market demand and market supply; individual firms do not
have any influence on the market price in perfect competition. Once the market price has been
determined by market supply and demand forces, individual firms become price takers. Individual
firms are forced to charge the equilibrium price of the market or consumers will purchase the product
from the numerous other firms in the market charging a lower price (keep in mind the key conditions
of perfect competition). The demand curve for an individual firm is thus equal to the equilibrium price
of the market.
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Demand Curve for a Firm in a Perfectly Competitive Market: The demand curve for an individual firm is equal to the
equilibrium price of the market. The market demand curve is downward-sloping.
The demand curve for a firm in a perfectly competitive market varies significantly from that of the
entire market.The market demand curve slopes downward, while the perfectly competitive firm’s
demand curve is a horizontal line equal to the equilibrium price of the entire market. The horizontal
demand curve indicates that the elasticity of demand for the good is perfectly elastic. This means that
if any individual firm charged a price slightly above market price, it would not sell any products.
A strategy often used to increase market share is to offer a firm’s product at a lower price than the
competitors. In a perfectly competitive market, firms cannot decrease their product price without
making a negative profit. Instead, assuming that the firm is a profit-maximizer, it will sell its goods at
the market price.
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QS Study
Home Accounting How Sunk Cost is considered irrelevant to decision about the future?
How Sunk Cost is considered irrelevant to decision about the

future?
Subject: Accounting
Topic: Accounting Management
Sunk cost is a cost that has already been incurred and, therefore, is irrelevant to the
decision-making process. One example is, a company purchased a machine several years
ago. Due to a change in fashion over several years, the product that is generated by the
machine cannot be sold to clients. Therefore the machine has become useless or obsolete.
The price originally paid to order the machine cannot be recovered by any action and it is,
therefore, a sunk cost.
Considered irrelevant to decision about the future: In addition to past cost, some future
costs may be irrelevant because they will be the same under all feasible alternatives. Those,
too, may be safely ignored for a particular decision. The salaries of many members of to
management are examples of expected future costs that will be unaffected by the decision at
hand.
Other irrelevant future costs include fixed costs that will be unchanged by such considerations
as whether machine X or machine Y is selected. However, it is not merely a case of saying
that fixed costs are irrelevant and variable costs are relevant. Variable costs can be irrelevant,
and fixed cost can be relevant.
For example, Sales commission might be paid on an order regardless of whether the order
was filled from plant G or plant H, variable costs are irrelevant whenever they do not differ
among the alternatives at hand and fixed costs are relevant whenever they differ between the
alternatives at hand.
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Consumer Surplus and Producer Surplus

Economic terms used to determine market wellness by studying the relationship between the consumers
and suppliers
Home › Resources › Knowledge › Economics › Consumer Surplus and Producer Surplus
What are Consumer Surplus and Producer Surplus?

Both consumer surplus and producer surplus are economic terms used to define market wellness by studying the
relationship between the consumers and suppliers. They explain the opportunity cost consumers forego to gain
a marginal benefit for buying a good or service. To the producer, it is the willingness and ability to produce an
extra unit of a product based on the marginal cost of producing more goods.

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Summary
 Both consumer surplus and producer surplus are economic terms used to define market wellness by studying
the relationship between the consumers and suppliers.
 The consumer surplus refers to the difference between what a consumer is willing to pay and what they paid
for a product.
 The producer surplus is the difference between the market price and the lowest price a producer is willing to
accept to produce a good.
Understanding Consumer Surplus and Producer Surplus
When discussing consumer and producer surplus, it is important to understand some base concepts used by
economists to explain the inter-relationship.
Both consumer and producer surplus can be graphed to display either a demand curve or marginal benefit curve
(MB) and a supply curve or marginal cost curve (MC).

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Consumer surplus refers to the monetary gain enjoyed when a purchaser buys a product for less than what they
normally would be willing to pay. Each corresponding product unit price along the supply curve is known as
the marginal cost (MC).

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On the other hand, the producer surplus is the price difference between the lowest cost to supply the market
versus the actual price consumers are willing to pay. The price of a product unit along the supply curve is
known as the marginal cost (MC).
When graphing consumer surplus, the area above every extra unit of consumption, is referred to as the total
consumer surplus. Similarly, the area above the supply curve for every extra unit brought to the market is
referred to as the total producer surplus.
When you add both the consumer and producer surplus, you get the total surplus, also known as total welfare or
community surplus. It is used to determine the well-being of the market. When all factors are constant, in a
perfect market state, an equilibrium is achieved. This state is also referred to as allocative efficiency – the
marginal cost and marginal benefit are equal.

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Understanding Consumer Surplus
To fully conceptualize consumer surplus, take an example of a demand curve of chocolates plotted on a graph.
The unit price is plotted on the Y-axis and the actual chocolate units of demand per day on the X units. The
graph below shows the consumer surplus when consumers purchase two units of chocolates.

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To calculate consumer surplus, account for Δ0 units. In the graph above, the corresponding unit price is $14. It
is the market price that consumers are able and willing to purchase a bar of chocolate.
Since the demand curve is linear, the shape formed between Δ0 unit to 2 and below the demand curve is
triangular. Therefore, the ordinary formula for finding an area of a triangle is used. The unit items cancel out to
leave the result expressed in monetary form.
Total Consumer Surplus Formula

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Where:
 Qn = Quantity of demand/supply either at equilibrium or the willing purchasing or selling price
 ΔP = The difference between the price at equilibrium or at the purchasing or selling point and the price at Δ0
In summation, the market saves $3 for the same unit it could’ve purchased for $14.
Understanding Producer Surplus
Using the same example with all the X and Y-axis numbers, the producer surplus is calculated using the same
formula. Below is the graph for the illustration:

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Calculating the Total Producer Surplus

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The producer surplus cost at two units is $4 ($6 – $2). This means that the supplier(s) will forego $4 per unit for
producing two units.
Total Surplus
In the previous example, the total consumer surplus was $3, and the total producer surplus $4, respectively. The
total surplus, therefore, will be $7 ($3 + $4). Below is the formula:
Total Surplus = Consumer Surplus + Producer Surplus

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In the above example, the total surplus does not depict the equilibrium. There is a deadweight to shed off.
Supplier overheads are higher for producing two units. Similarly, the consumer is getting less than what the
market can offer.
As a result, to achieve a stable market, the producer(s) must increase the production to reduce the deadweight
and attain the equilibrium. At the equilibrium, the consumer(s) will enjoy the highest marginal utility, and
supplier(s) will maximize profits.
Related Readings
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In order to help you become a world-class financial analyst and advance your career to your fullest potential,
these additional resources will be very helpful:
 Demand
 Marginal Benefit
 Deadweight Loss
 Marginal Utility
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Definition
Definition of 'Producer Surplus'

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Definition: Producer surplus is defined as the difference between the amount the producer is willing to
supply goods for and the actual amount received by him when he makes the trade. Producer surplus is a
measure of producer welfare. It is shown graphically as the area above the supply curve and below the
equilibrium price.
Here the producer surplus is shown in gray. As the price increases, the incentive for producing more
goods increases, thereby increasing the producer surplus.
Description: A producer always tries to increase his producer surplus by trying to sell more and more
at higher prices. However, it is simply not possible to increase the producer surplus indefinitely since at
higher prices there might be very little or no demand for goods.
What is a Producer Surplus?

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DEFINITION:
Producer surplus is the amount of money a producer receives from selling goods that is above the
minimum amount they were willing to accept for them.
🤔 Understanding producer surplus

Producer surplus refers to the gain a seller gets from a sale - the amount of money they receive in excess of
the minimum price at which they would sell the item. It’s a producer’s revenue minus their direct costs of
production minus their opportunity costs, or the cost of foregoing the value another use of their resources
might bring. It’s a way of considering the workings of a free market in which both producers and consumers
benefit. For a transaction to be successful, the price must fall between the minimum the seller will accept,
and the maximum the buyer will pay. Consequently, the seller receives more than their lowest acceptable
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price (producer surplus), and the buyer gets the item for less than they were willing to pay (consumer
surplus).
EXAMPLE
Suppose Tom has an old car he wants to sell. He would accept anything over $2,500 for it. If he can’t get at
least that much, he would rather give it to his niece for her birthday than let a stranger have it that cheaply.
When a buyer comes along, he ends up selling the car for $2,750. That’s $250 more than his minimum, and
that $250 is his producer surplus.
Takeaway
Producer surplus is like getting a raise you didn’t ask for at work…
When you work, you agree to sell an hour of your time for a certain amount of money - your salary. Your
paycheck is what you expect to get, the minimum you’re willing to accept for the work you do. Imagine that
one day when you clock out and you get your paycheck, it’s $100 more than you expected, and there’s a
note from your boss that says, “I’m giving you a raise because of all your hard work!” The raise means you’re
getting more money than the minimum you required to show up. You’re getting paid more, and that’s
similar to producer surplus.

Economics Assignment1

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MBA Program - Managerial Economics - Group assignment

Perfect competition is commonly characterized by four conditions.

1. A large number of firms supply a good or service for a market consisting of

a large number of consumers.

compete only with respect to price. In addition, all consumers have

at a single market price.

industry output, and, therefore, its actions have no impact on price.

Each firm takes the price as given—indeed, determined by supply and

demand. Similarly, each consumer is a price taker, having no

influence on the market price.

It is important to remember that these conditions characterize an ideal

model of perfect competition. Some competitive markets in the real world

will compare the model to real-world markets.

decisions influence total industry output and price.

is irrelevant to the firm’s current decision. As we observed earlier, in the

case of excess, unused factory capacity, the relevant opportunity cost is

$10 million is needed to complete a prototype product that (because of delays)

and ignominiously (and literally) became a sunk cost.

232 Chapter 6 Cost Analysis

were initiated in the 1980s (because of worsening profit prospects), many

it never received regulatory approval to operate, and the enormous sums

spent came to nothing.

is irrelevant to the firm’s current decision. As we observed earlier, in the

case of excess, unused factory capacity, the relevant opportunity cost is

$10 million is needed to complete a prototype product that (because of delays)

and ignominiously (and literally) became a sunk cost.

232 Chapter 6 Cost Analysis

were initiated in the 1980s (because of worsening profit prospects), many

utilities continued to spend on plants already in progress, despite equally

it never received regulatory approval to operate, and the enormous sums

spent came to nothing.

3) Producer Surplus and Profit in Short-Run Competitive Equilibrium

What is a Producer Surplus?

🤔 Understanding producer surplus

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What is a producer surplus?

Why is producer surplus important?

What is the difference between a producer surplus and a consumer

What is the difference between a producer surplus and profit?

How is producer surplus measured?

Is producer surplus good or bad?

How do you maximize producer surplus?

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Updated June 19, 2020

Updated January 30, 2021

Updated January 30, 2021

What is the Law of Supply?

What is the Law of Demand?

What is the Law of Supply and Demand?

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