In the bread market supply and demand diagram, the total producer surplus is depicted as the area positioned above the supply curve and below the horizontal line that represents the market price. [1]

Visualizing Total Producer Surplus in the Bread Market

Analogous to demand elasticity for consumers, supply elasticity is a measure used to gauge the responsiveness of the quantity supplied by producers to a change in a product's price. [1, 3]

Elasticity of Supply

Figure E8.5 is a diagram that shows how to visualize both consumer and producer surplus when a specific quantity of a good, Q₀, is sold at a price, P₀, that is not necessarily the equilibrium price. The consumer surplus is represented by the area beneath the demand curve and above the horizontal price line at P₀. Similarly, the producer surplus is the area located above the supply curve and below the price line P₀. The figure illustrates this with Q₀ = 3,000 and P₀ = €2.50.

Visualization of Consumer and Producer Surplus at a Non-Equilibrium Point (Figure E8.5)

The surplus for a producer on a specific unit of a good is the difference between the price received for that unit ($P_0$) and the marginal cost of producing it ($C'(q)$). The formula is: Surplus = $P_0 - C'(q)$. On a supply and demand graph, this surplus is represented by the vertical distance between the horizontal price line at $P_0$ and the supply curve at quantity $q$. This calculation is based on the principle that the market supply curve represents the marginal cost of production for each successive unit.

Calculating an Individual's Producer Surplus

When treating quantity as a continuous variable, total producer surplus can be calculated with integration for any given price $P_0$ and quantity sold $Q_0$, irrespective of whether it's a market equilibrium point. The surplus is the integral of the price minus the marginal cost ($P_0 - C'(q)$) from zero to $Q_0$: Total Producer Surplus = $\int_{0}^{Q_0} (P_0 - C'(q)) \,dq$. This is equivalent to the formula $P_0Q_0 - C(Q_0) + C(0)$, where $C(0)$ represents the firm's fixed costs. This expression effectively calculates total revenue ($P_0Q_0$) minus the total variable costs ($C(Q_0) - C(0)$).

Calculating Total Producer Surplus Using Integration

Producer surplus and profit are distinct measures of a firm's economic rent, with the key difference lying in their respective outside options. Producer surplus represents the rent a firm gains relative to the outside option of not producing but still incurring fixed costs. In contrast, profit is the economic rent received relative to the outside option of exiting the market entirely, thereby avoiding all costs, including fixed ones. This leads to the mathematical relationship: Profit = Producer Surplus - Fixed Costs. [2, 3, 4] On a graph like Figure 7.19, profit is the area between the price and the average cost curve, while the firm's fixed costs are represented by the remaining portion of the producer surplus area. [2]

Relationship Between Producer Surplus, Profit, and Fixed Costs

A producer's surplus on a single unit of a good is the difference between the selling price and the marginal cost to produce that unit. The total producer surplus, often simply called 'producer surplus', is the sum of these individual surpluses for all units sold. This total represents the economic rent a firm gains from selling its product over the alternative of not selling. It's important to distinguish total producer surplus from a firm's total profit, as the surplus calculation does not subtract fixed costs.

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Alfred Marshall (1842–1924) was a highly influential economist and a key founder of the neoclassical school of economics, whose work was driven by a desire to improve the material conditions of the working class. His book, *Principles of Economics*, first published in 1890, became the standard introductory textbook in the English-speaking world for half a century; its eighth edition was published in 1920 by MacMillan & Co. in London. A talented mathematician, Marshall advanced the study of supply and demand by using calculus to explain the functions of markets and firms. This work helped to formalize crucial economic concepts, including marginal cost, marginal utility, consumer surplus, and producer surplus. He is also noted for introducing the foundational model of supply and demand, often using the corn exchanges in English towns as a practical example. Marshall emphasized the importance of facts, and his observation that large firms could achieve lower unit production costs than smaller ones was central to his analysis. [1, 3] However, this particular insight was largely overlooked by subsequent neoclassical economists.

Alfred Marshall (1842–1924)

The total surplus, representing the combined gains from trade in a market, is the sum of the consumer surplus and the producer surplus. While this calculation shows how benefits from transactions are divided, the total surplus itself depends only on the quantity of the good sold, not its price. This is because for any given transaction, the price paid is a loss for the consumer but an equal gain for the producer. Therefore, when these individual surpluses are aggregated to find the total surplus, the price transfer between the two parties cancels out, making the total surplus a function solely of the quantity exchanged, N(Q).

Total Surplus as a Price-Independent Sum of Consumer and Producer Surplus

To cite the ebook, use The CORE Econ Team 2023 The Economy 2.0: Microeconomics Open access e-text https://core-econ.org/the-economy/.

To cite a unit, use The CORE Econ Team 2023 The Economy 2.0: Microeconomics Open access e-text https://core-econ.org/the-economy/ Unit [unit number] (url).

CORE Econ - The Economy 2.0: Microeconomics

Developed by Alfred Marshall, this model explains how prices are determined in markets with numerous buyers and sellers of identical goods. It proposes that a supply curve is shaped by the prices sellers are willing to accept, while a demand curve is determined by the willingness to pay of buyers. A key assumption of this model is that all goods being traded are homogeneous. Marshall contended that through the process of 'higgling and bargaining' in such a market, the price would consistently move towards an equilibrium level where the quantity that buyers demand equals the quantity that sellers supply.

Marshall's Model of Supply and Demand

Marginal cost (MC) represents the additional cost a firm incurs to produce more output. It can be viewed in two ways: for discrete changes, it is the cost of producing one additional unit. More generally, when quantity (Q) is treated as a continuous variable, the marginal cost is the derivative of the total cost function, C(Q), with respect to Q. This represents the instantaneous rate of change in total cost and corresponds to the slope of the total cost function. [1, 2]

Marginal Cost

Marginal utility is the additional satisfaction or benefit resulting from a one-unit increase in the consumption of a good. More formally, it is the rate of change in total utility as the quantity of the good consumed increases. In economic models, marginal utility is often calculated using partial derivatives.

Marginal Utility

Consumer surplus represents the total monetary benefit that consumers gain from purchasing a good, considered as the economic rent they receive over the alternative of not buying it. It is calculated by summing the individual surpluses of all consumers who buy the product. For a continuous quantity of the good, the total consumer surplus is determined by integrating the individual surpluses across all purchasing consumers.

Consumer Surplus

Producer Surplus

A key part of Alfred Marshall's economic analysis was his observation that larger firms were capable of producing goods at a lower cost per unit compared to smaller firms. [1, 3] This concept, central to his work, was not incorporated into the mainstream neoclassical school of thought that followed him. [2]

Marshall's Observation on Economies of Scale

Alfred Marshall, a key founder of the neoclassical school of economics, expressed strong disapproval of the *Homo economicus* model, which assumes individuals are driven solely by self-interest. He would have been distressed by this concept becoming central to the textbooks of his followers. Marshall argued that ethical considerations are crucial for economists to analyze. In his 1890 book, *Principles of Economics*, he stated: 'Ethical forces are among those of which the economist has to take account. Attempts have indeed been made to construct an abstract science with regard to the actions of an economic man who is under no ethical influences and who pursues pecuniary gain... selfishly. But they have not been successful.'

Marshall's Disapproval of Homo Economicus

Alfred Marshall, who was instrumental in promoting the use of mathematics in economics, also warned against its potential for misuse. He outlined his personal guidelines for applying mathematics in the discipline in correspondence with A. L. Bowley, who was also a mathematically-oriented economist.

Marshall's Cautionary View on Mathematical Economics

In his 1890 publication, *Principles of Economics*, Alfred Marshall outlined what he considered the primary objective of the field. He contended that the 'chief and highest interest' of economics is to investigate whether the existence of a 'lower class' is a societal necessity. This inquiry delves into whether it is unavoidable that a large segment of the population must endure poverty and toil to facilitate a cultured and refined life for others, while being excluded from participating in that life themselves. Marshall believed that economics, through the application of factual analysis and inference, was the essential discipline for addressing this fundamental question about poverty and social hierarchy.

Marshall's View on the Core Purpose of Economics

In the Beautiful Cars model, the total producer surplus at the profit-maximizing output is visually depicted as a rectangular area. This area is precisely defined by the vertices at (0, \$14,400), (0, \$27,200), the profit-maximization point E (32, \$27,200), and (32, \$14,400).

Visualizing Total Producer Surplus as an Area in the Beautiful Cars Model

The total surplus gained by all consumers in the Beautiful Cars model is visually represented as the triangular area on the price-quantity graph. This area is situated below the demand curve and above the firm's profit-maximizing price line of \$27,200. The vertices defining this triangle are (0, 27,200), (0, 40,000), and the profit-maximization point E (32, 27,200).

Visualizing Total Consumer Surplus as an Area in the Beautiful Cars Model

In any market, the way the total surplus is shared between consumers and producers is determined by the relative elasticities of the demand and supply curves. [7] The group that is less responsive to price changes (the more inelastic side of the market) will gain a larger portion of the surplus.

Relative Elasticities and Surplus Distribution

The total gains from trade in the bread market are calculated as the sum of the consumer and producer surpluses. [1] Visually, this corresponds to the entire area between the supply and demand curves up to the equilibrium quantity. [1] This total surplus quantifies the market's benefit compared to the alternative scenario where no bread is produced or exchanged. [1]

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