Question

Which of the following would increase producer surplus in the market for steel chairs? (Hint: draw the supply-demand diagram)

A. Incomes rise, and steel chairs are inferior goods.

B. The price of steel tables (a complement) rises.

C. The price of aluminum chairs (a substitute) rises.

D. Both (A) and (C) are correct.

Answer 1

Producer Surplus is defined as the difference between the price which the seller receives and the price at which the seller wants to sell the product. It is given by the area above the supply curve and below the price line. As the equilibrium price increases, the producrer surplus increases and as the equilibrium size decreases, the producer surplus decreases.

In option (A), if steel chairs are inferior goods and income increases, the demand for steel chairs will decline as they are inferior goods. Thus the demand curve will shift to the left and equilibrium price wil decrease. So the producer surplus will decrease. So, it is incorrect.

In option (B), as price of steel tables decreases, the quantity demanded for steel tables increases. As steel tables are a complements for steel chairs, the demand for steel chairs will also decrease Thus the demand curve will shift to the left and equilibrium price will decrease. The producer surplus will also decrease. So, this option is also incorrect.

In option (C), as price of aluminium chairs rises, the quantity demanded for aluminium chairs decreases. As aluminium chairs are substitutes for steel chairs, the demand for steel chairs will increase. So the demand curve will shift to the right and equilibrium price will increase. Thus the producer surplus will increase. So, this option is correct.

So, the answer is (C).

The demand-supply diagram is shown below: