Producer surplus is the difference between the amount of money a producer is ready to charge for a given quantity of goods and the actual amount that the same producer receives for the same amount of products in the market. For example, if the cost of producing an item is $400, the producer may be willing to accept $400 for the sale of the item. However, if the item sells at the market price of $500, the extra $100 benefit that the producer receives becomes the surplus amount.
According to the law of supply, all producers must receive a surplus in scenarios where they produce and sell more than one unit of a commodity compared to when only one unit of the product is sold. This market phenomenon occurs due to the increase in marginal costs, which is the cost of producing an additional unit of a product. Notably, as market prices increase, the volume of commodities produced and also supplied increases. Consequently, the producer incurs additional costs of production, which drives them to sell the extra unit of the product at a higher price.
For example, if a manufacturer incurs $400 in the production of pieces of jewelry, they may be willing to accept $400 for the first unit of the commodity produced. However, if the marginal cost for the production of an additional unit of pieces of jewelry is $500, the manufacturer may be unwilling to accept $400 for the second unit. Further, assuming that the market price for the pieces of jewelry is $450, there will exist a $50 surplus when the first and subsequent quantities of the product are sold. This example shows that if the marginal costs increase, the producer records a surplus benefit for every additional unit of production as compared to when one unit is sold.
The producer surplus must increase when the price of a product rises due to the nature of the supply curve and the price homogeneity. Notably, the supply curve is upward sloping, implying that a surplus can only be derived where there exists a difference between the old (lower) and new (higher) price. Furthermore, the fact that the cost of goods is homogenous in the market allows producers to experience a surplus.
The function of production draws the relationship between the amount of output derived from a given quantity of input. For example, the production function may draw on a link between the volume of goods produced and the number of workers hired in a manufacturing facility. In an economics view, the slope of production function falls as more workers are employed as a result of a reduction of the marginal product following an increase in further input.
According to neoclassical economists, marginal product is the change in the quantity of output following an alteration in the volume of input. Notably, it is argued that the production function falls due to the significant reduction in the output when the input increases. For example, when a firm hires additional employees to work in a plant, the quantity of output, or goods produced increases proportionately, since more labor is available to facilitate quicker production. However, at a given point, the production function flattens and begins to decline due to the law of diminishing returns. Notably, production reaches the optimum level, and the extra workers only begin lowering productivity among each other.
Economists argue that the average total cost (ATC) curve falls then increases as more output is produced in the short-run, thus resulting in a U-shaped ATC curve. This phenomenon occurs as a result of the combination of ATC costs, which include fixed and variable costs. Notably, in the beginning, the fixed factors of production of the firm are constant. Therefore, the fixed costs are utilized more efficiently when larger units of outputs are produced. Conversely, the variable costs are subject to changes, such as the increase in labor to facilitate a raise in the units of output. Therefore, when combined, the two costs form a U-shape since the average fixed costs decrease while the variable costs increase with an increase in the number of units of output.
Similarly, to the short-run ATC curve, the long-run ATC curve is also U-shaped. The curve appears so due to changes in the fixed costs, which are absent in the short-run. Notably, in the long-run, both the fixed and variable costs of a firm can be altered to enable a firm to lower its cost per unit of production. For example, in the long run, a firm may have a variety of alternatives of different sizes of production plants to select from, to lower its costs, maximize output and profit. If the firm anticipates lower output, it may choose the smallest plant that is associated with a lower cost of production per unit to maximize output. The firm may also expand this fixed factor of production, to the medium and large production plant, depending on the anticipated rate of output. Therefore, in the long-run, the fixed cost decreases with an increase in the rate of output up to a certain point where the economies of scale are fully utilized, and the firm can no longer optimize efficient use of the fixed factor of production. For this reason, the firm begins to experience a diseconomy of scale, whereby the cost per unit of production begins to increase. At this point, the long-run ATC curve changes its course and begins sloping upward, as the cost per unit continues to increase significantly.
Monopolies and perfectly competitive firms produce the output where MR=MC because of a more significant consideration of the profits that can be generated at this point. As noted in assignment five, the marginal revenue is the additional benefit of selling an extra unit of a product, while the marginal cost is the additional cost of producing an extra unit of a commodity. Therefore, considering a perfectly competitive and monopoly market, profit can only be generated where the MC=MR or MC is less than MR. Conversely, if the MC is higher than the MR, firms operating in both markets are likely to make losses by selling an additional unit of a product. Hence, it is likely that monopolies and perfectly competitive firms produce the output at MR=MC because it is at this point that an extra unit of a product is expected to earn a profit.
However, despite both market structures producing output where MR=MC, the profit-maximizing price is higher than MC for the monopoly and equal to MC for perfect competition due to the nature of demand and demand curve in the two markets. Notably, the demand curve in a perfectly competitive market is perfectly horizontal. This type of demand curve signifies the perfect elasticity of a product, whereby the quantity demanded falls to zero with an increase in the market price. Often, this occurs due to the nature of a perfectly competitive market, whereby there exist several sellers with homogenous products. As such, if a firm charges a higher price than the MC, their demand among consumers decline, as the latter seeks for more favorable rates from other sellers. Hence, the profit-maximizing amount for the perfect competition must be equal to MC.
On the other hand, the profit-maximizing price is higher for the monopoly due to the nature of demand and demand curve in the market. Notably, demand in a monopolistic market is inelastic, which implies that the quantity demanded may only decline as a result of an increase in price. Therefore, a firm operating in a monopolistic market can charge the maximum amount in the demand curve without losing demand among consumers. Consequently, it can be concluded that the profit-maximizing price for the monopoly is higher than the MC in the market.
As noted, monopolies and perfectly competitive markets produce an output where MC=MR. Therefore, even when manufacturing the profit-maximizing output, the two types of markets may make losses if the average cost of production is lower than the average amount of revenue.
Also, monopolies and perfectly competitive firms may stay in business and continue to produce in the short-run even when making losses under the condition that they manufacture a volume of products where MR=MC. In this condition, the firms can adequately minimize losses without the need to exit the industry.
Both monopolies and perfectly competitive firms maximize profits by producing output where MR=MC. Nonetheless, monopolies lead to a deadweight loss as compared to their counterparts because they possess absolute market power to define their pricing mechanism.
Notably, deadweight loss refers to the economic loss to society created by market inefficiency. In the context of monopolies, deadweight loss occurs because monopolies utilize their market power to set high prices for their products, thus forgoing a certain level of transaction with consumers who cannot meet the set prices. Conversely, in perfect competition, firms lack the absolute market power to set high prices due to the risk of losing the consumer base. Therefore, compared to monopolies, a perfectly competitive market cannot lead to a deadweight loss.
Even though monopolies often set higher prices compared to other market structures, their prices may be lower than those of a perfectly competitive market in instances of government regulation. For example, if the government introduces price caps, monopolies may be forced to set lower prices compared to even firms in perfectly competitive markets. Also, the nationalization of monopolies may be a significant factor for a reduction in their rates relative to their counterparts.
A monopolistic market is characterized by several firms that provide differentiated products, which are not close substitutes. Often, the sellers and consumers in this type of market have imperfect knowledge of the market. Despite a monopolistic market having too many firms, the price which consumers pay does not reduce because firms in the industry have the market power to set prices.
Market power is the ability of firms to raise the prices of their products without losing a significant fraction of their customers. This scenario is present in a monopolistic market whereby firms raise prices higher than MC without losing customers. The market power in a monopolistic market arises from product differentiation and a lack of close substitutes. Notably, despite there being several firms in the market, products are highly differentiated, thereby a firm can efficiently increase its prices without the fear of losing its customers to substitute products.
The product and labor market have several things in common, including their working mechanisms, notably, the two function based on demand and supply. For example, in the product market, demand for goods and services drives further production and supply by the producers. Similarly, employees offer their services to fulfill the need for labor in the labor market. Despite the numerous similarities, the two markets differ significantly based on the parties that demand the product and labor and the function of forces of demand and supply in setting the prices and quantities in both markets.
The parties that demand products and labor create a significant distinction between the two markets. Notably, in the product market, commodities are manufactured by firms to satisfy the demand among consumers. For example, clothes are made and supplied by firms and are demanded by final consumers. Conversely, firms are the primary parties that require labor, while households provide their services in the labor market.
Furthermore, the two markets differ based on the function of forces of demand and supply in setting the prices and quantities of each supply. On the one hand, demand in the product market determines the volume of goods supplied. For example, if the need for a commodity is high, firms may strive to ensure that production is enhanced to meet the demand. On the other hand, the demand-supply mechanism is complicated in the labor market in the sense that an increase in wages does not foster a rise in labor supply. Therefore, the demand-supply mechanism is linear in the product market and non-linear in the labor market.
Economists argue that the value of the marginal product curve for labor is the demand-for-labor curve in a perfectly competitive labor market. On the one hand, the marginal product curve, also considered as the marginal revenue product of labor in a perfectly competitive market, depicts the additional benefit that a firm is likely to enjoy for increasing its labor supply by one unit. Simply put, the marginal product curve illustrates the relationship between change in output (marginal product) following an alteration in the quantity of input employed by a firm. On the other hand, the demand-for-labor curve illustrates the relationship between marginal product and the amount of input employed by an organization. Therefore, given that the demand-for-labor curve shows the value of output as a function of variable input used by a firm implies that the value of the margin-product curve for labor is also the demand-for-labor curve in a perfectly competitive labor market.
Like the product market, the labor market also experiences a shift in demand and supply of labor. A shift in the demand for labor is caused by several factors, among them changes in the quantity of output of a product. As noted, the demand for labor in the market is a derived demand, meaning that its need is a consequence of the demand for products among consumers. Therefore, a shift in demand for labor is triggered by a change in the output demanded. For example, if customers demand additional units of a commodity such as mobile phones, the demand for labor may shift to the right, as firms seek for extra employees to meet the production needs.
Also, changes in production processes cause a shift in demand for labor. For example, if a production process uses less workforce, the demand for labor may shift to the left as fewer employees would be required to meet production needs. Similarly, when a production process uses more workforce, the demand curve shifts to the right as more employees are sought to meet the production needs.
A shift in the supply of labor can be caused by a myriad of factors, among them the number of available workers. Notably, when the number of available workers is high, the supply of labor also increases significantly. The availability of workers is affected by several factors, such as demographic patterns. For example, if a country is characterized by an aging population, it is likely for the availability of workers to be lower, thus decreasing the supply of labor in the market. Similarly, a young population can be attributed to a higher number of available workers, and consequently, an increase in the supply of labor.
Additionally, government policies are critical factors that cause a shift in the supply of labor. Notably, when the government intervenes in the labor market by introducing stringent labor policies, the supply of labor is likely to shift to the left. For example, when the government sets stringent employment qualifications, more employees are less likely to meet such requirements, thus creating a reduction in the supply of labor in the affected industry. Similarly, when the government is lenient on job requirements, the supply of labor shifts to the right.
The wage differential is a common phenomenon in the labor market, whereby some workers receive higher wages compared to other employees. While wage differential may result from discrimination in the workplace, from an economic perspective, the differential may arise from other factors in the labor market. These factors include the availability of labor unions, the nature of skills among workers, seniority of the employee, and the nature of demand and supply in an industry.
The availability of labor unions is among the reason why some workers receive higher wages than others. Notably, if there are adequate labor unions in an industry, an employee may receive a higher salary, as the former negotiate for higher and better pay for their members. Conversely, if an employee operates in an industry with inadequate labor unions, they may receive lower wages as they may lack a formal body to negotiate for better wages.
Furthermore, the nature of skills possessed by workers determines their amount of wages. Notably, employees with multiple skills may receive higher remuneration than their counterparts, as the former can undertake several tasks in an organization.
The seniority of an employee is also a significant factor that determines their amount of wages. Arguably, employees who have been in a firm for the longest time are likely to receive higher salaries compared to their counterparts due to the periodic pay raises they receive throughout the years.
Additionally, differences in demand and supply of labor can create wage differential. Notably, employees in an industry with low labor supply are likely to receive higher wages to enhance their willingness to remain in a firm. Also, if the demand for labor is low, and the supply is high, employers may offer lower wages without the risk of experiencing a labor shortage.