Cost and the Willingness to Sell

Imagine now that you are a homeowner and you need to get your house painted. You turn to four sellers of painting services: Mary Frida, Georgia and Grandma. Each painter is willing to do the work for you if the price is right. You decide to take bids from the four painters and auction off the job to the painter who will do the work for the lowest price.

Each painter is willing to take the job if the price she would receive exceeds her cost do doing the work. Here the term cost should be interpreted as the painters opportunity cost. It includes the painters out-of-pocket expenses for paint, brushes and so on) as well as the value that the painters place on their own time. Each painter’s cost. Because a painter’s cost is the lowest price she would accept for her worke cost is a measure of her willingness to sell her services. Each painter would be eager to sell her services at a price greater than her cost and she would refuse to sell service at a price less than her cost. At a price exactly equally to her cost she would be indifferent about selling her service. She would be equally happy getting the job or walking away without incurring the cost.

When you take bids from the painters the price might start off high but it quickly falls as the painters compete for the job. Once Grandma has bid ( or slightly less) she is the sole remaining bidder, Grandma is happy to do the job for this price because her cost is only $500. Mary Frida and Georgia are unwilling to do the job for less than. Note that the job goes to the painter who can do the work at the lowest cost.

What benefit does Grandma receive from getting the job? Because she is willing to do the work for but gets for doing it we say that she receives producer surplus. Producer surplus is the amount a seller is paid minus the cost of production. Producer surplus measures the benefit to sellers of participating in a market.

Now consider a somewhat different example. Suppose that you have two houses that need painting. Again you aution off the jobs to the four painters. To keep thing simple let’s assume that no painter is able to paint both houses and that you will pay the same amount to paint each house. Therefore the price falls until two painters are left.

In this case the bidding stops when Georgia and Grandma each offer to do the job for a price of or slightly less. At this price Georgia and Grandma are willing to do the work and Mary and Frida are not willing to bid a lower price. At a price of Grandma receives producer surplus of and Georgia receives producer surplus. The total producer surplus in the market.

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