Question

A firm is operating in a perfectly competitive environment. A change in the market condition leads to an increase in the firm’s profit by an amount K. Which of the following describes the change in the Producer’s Surplus due to the above change in the market condition?

• A. The Producer’s Surplus increases by K
• B. The Producer’s Surplus increases by less than K but greater than 0
• C. The Producer’s Surplus changes but it is not possible to know the direction of the change
• D. The Producer’s Surplus doesn’t change

Answer 1

The Correct Option is A

In a perfectly competitive market, a firm is a price taker, and its profit is calculated as the difference between total revenue and total cost. Producer's surplus is defined as the difference between what producers are willing to accept for a good or service versus what they actually receive. It can also be seen as the area above the supply curve and below the market price.

Let's analyze the change in producer's surplus:

• Given that the firm's profit increases by an amount K, this implies an increase in the difference between total revenue and total cost.
• In a perfectly competitive market, if there's an increase in profit, this can often result from a higher market price or a reduction in costs.
• Since producer's surplus is the area above the supply curve up to the market price, any increase in profit directly contributes to an increase in producer's surplus by the same amount, provided that all other factors remain constant.

Therefore, the correct answer is that the producer's surplus increases by K.

Let's evaluate the other options:

• The Producer’s Surplus increases by less than K but greater than 0: This would be incorrect because a direct increase in profit by K, without changes in other contributing factors, translates directly to the same increase in producer's surplus.
• The Producer’s Surplus changes but it is not possible to know the direction of the change: As discussed, with specific information on the change in profit, we can determine the direction and magnitude of the change in producer's surplus.
• The Producer’s Surplus doesn’t change: This is not accurate because the increase in profit indicates a direct increase in producer's surplus.

Hence, the proper conclusion is that the Producer’s Surplus increases by K.