A Level Economics AQA Practice Exam

What happens to producer surplus when prices fall?

1. It increases due to higher sales volume

2. It decreases as the revenue potentially declines

3. It remains constant regardless of price changes

4. It becomes negative for the firm

The correct answer is: It decreases as the revenue potentially declines

When prices fall, the producer surplus is affected largely due to a decrease in the revenue that firms can generate from selling their products. Producer surplus is defined as the difference between the amount producers are willing to accept for a good or service (their cost) and the amount they actually receive (the market price). When prices drop, the market price that producers receive decreases. If the market price falls below the minimum price a producer is willing to accept, it can lead to a drop in overall revenue, causing producer surplus to decrease. Even if sales volume may increase slightly due to lower prices, the overall effect is often negative on surplus, particularly for firms that may not be able to sustain operations at lower price levels. This highlights a crucial relationship in economics between price, revenue, and producer surplus. As a result, the conclusion that producer surplus decreases as prices fall is consistent with the economic principles governing supply and demand dynamics.