458 ? Chapter 7/Consumers, Producers, and the Efficiency of Markets SHORT ANSWER1.
Answer each of the following questions about demand and consumer surplus.
a. What is consumer surplus, and how is it measured?
b. What is the relationship between the demand curve and the willingness to pay?
c. Other things equal, what happens to consumer surplus if the price of a good falls? Why? Illustrate
using a demand curve.
d. In what way does the demand curve represent the benefit consumers receive from participating in a
market? In addition to the demand curve, what else must be considered to determine consumer surplus?
ANS:
a. Consumer surplus measures the benefit to buyers of participating in a market. It is measured as the
amount a buyer is willing to pay for a good minus the amount a buyer actually pays for it. For an individual purchase, consumer surplus is the difference between the willingness to pay, as shown on the demand curve, and the market price. For the market, total consumer surplus is the area under the demand curve and above the price, from the origin to the quantity purchased.
b. Because the demand curve shows the maximum amount buyers are willing to pay for a given
market quantity, the price given by the demand curve represents the willingness to pay of the marginal buyer.
c. When the price of a good falls, consumer surplus increases for two reasons. First, those buyers
who were already buying the good receive an increase in consumer surplus because they are paying less (area B). Second, some new buyers enter the market because the price of the good is now lower than their willingness to pay (area C); hence, there is additional consumer surplus generated from their purchases. The graph should show that as price falls from P2 to P1, consumer surplus increases from area A to area A+B+C.
d. Since the demand curve represents the maximum price the marginal buyer is willing to pay for a
good, it must also represent the maximum benefit the buyer expects to receive from consuming the good. Consumer surplus must take into account the amount the buyer actually pays for the good, with consumer surplus measured as the difference between what the buyer is willing to pay and what he/she actually paid. Consumer surplus, then, measures the benefit the buyer didn't have to \
PriceAP2BP1CDFDemandQ2Q1QuantityDIF: 2 REF: 7-1 TOP: Consumer surplus NAT: Analytic
MSC: Interpretive
LOC: Supply and demand
Chapter 7/Consumers, Producers, and the Efficiency of Markets ? 459
2.
Tammy loves donuts. The table shown reflects the value Tammy places on each donut she eats:
$0.60 $0.50 $0.40 $0.30 $0.20 $0.10 Value of first donut Value of second donut Value of third donut Value of fourth donut Value of fifth donut Value of sixth donut a. Use this information to construct Tammy's demand curve for donuts. b. If the price of donuts is $0.20, how many donuts will Tammy buy?
c. Show Tammy's consumer surplus on your graph. How much consumer surplus would she have
at a price of $0.20?
d. If the price of donuts rose to $0.40, how many donuts would she purchase now? What would
happen to Tammy's consumer surplus? Show this change on your graph.
10.90.80.70.60.50.40.30.20.1123456PriceANS:
a.
Demand78Quantityb. At a price of $0.20, Tammy would buy 5 donuts.
c. The figure below shows Tammy's consumer surplus. At a price of $0.20, Tammy's consumer surplus
would be $1.00.
10.90.80.70.60.50.40.30.20.11234560.10.10.10.10.10.10.10.10.10.1Price
Demand78Quantity
d. If the price of donuts rose to $0.40, Tammy's consumer surplus would fall to $0.30 and she would
purchase only 3 donuts.
460 ? Chapter 7/Consumers, Producers, and the Efficiency of Markets
10.90.80.70.60.50.40.30.20.11234560.10.10.1PriceDemand78QuantityDIF: 2 REF: 7-1 TOP: Consumer surplus 3.
NAT: Analytic
MSC: Applicative
LOC: Supply and demand
Answer each of the following questions about supply and producer surplus. a. What is producer surplus, and how is it measured?
b. What is the relationship between the cost to sellers and the supply curve?
c. Other things equal, what happens to producer surplus when the price of a good rises? Illustrate
your answer on a supply curve.
ANS:
a. Producer surplus measures the benefit to sellers of participating in a market. It is measured as the
amount a seller is paid minus the cost of production. For an individual sale, producer surplus is measured as the difference between the market price and the cost of production, as shown on the supply curve. For the market, total producer surplus is measured as the area above the supply curve and below the market price, between the origin and the quantity sold.
b. Because the supply curve shows the minimum amount sellers are willing to accept for a given
quantity, the supply curve represents the cost of the marginal seller.
c. When the price of a good rises, producer surplus increases for two reasons. First, those sellers
who were already selling the good have an increase in producer surplus because the price they receive is higher (area A). Second, new sellers will enter the market because the price of the good is now higher than their willingness to sell (area B); hence, there is additional producer surplus generated from their sales. The graph should show that as price rises from P1 to P2, producer surplus increases from area C to area A+B+C.
PriceSupplyP2AP1CGBDQ1Q2QuantityDIF: 2 REF: 7-2 TOP: Producer surplus NAT: Analytic
MSC: Interpretive
LOC: Supply and demand
Chapter 7/Consumers, Producers, and the Efficiency of Markets ? 461
4. Given the following equations two equations:
1) Total Surplus = Consumer Surplus + Producer Surplus 2) Total Surplus = Value to Buyers - Cost to Sellers
Show how equation (1) can be used to derive equation (2).ANS:
Start with the equation: Total Surplus = Consumer Surplus + Producer Surplus. Then, since Consumer Surplus = Value to buyers - Amount paid by buyers, and since Producer Surplus = Amount received by sellers - Costs of
sellers, then Total Surplus can be written as: Value to buyers - Amount paid by buyers + Amount received by sellers - Costs of sellers. Since the Amount paid by buyers equals the Amount received by sellers, the middle two terms cancel out and the result is:
Total Surplus = Value to buyers - Costs of sellers.
DIF: 2
TOP: Total surplus REF: 7-3 NAT: Analytic
MSC: Analytical
LOC: Supply and demand
462 ? Chapter 7/Consumers, Producers, and the Efficiency of Markets 5.
Answer the following questions based on the graph that represents J.R.'s demand for ribs per week of ribs at
Judy's rib shack. a. b. c. d. e. f. g. h. i.
At the equilibrium price, how many ribs would J.R. be willing to purchase? How much is J.R. willing to pay for 20 ribs?
What is the magnitude of J.R.'s consumer surplus at the equilibrium price? At the equilibrium price, how many ribs would Judy be willing to sell? How high must the price of ribs be for Judy to supply 20 ribs to the market? At the equilibrium price, what is the magnitude of total surplus in the market? If the price of ribs rose to $10, what would happen to J.R.'s consumer surplus? If the price of ribs fell to $5, what would happen to Judy's producer surplus?
Explain why the graph that is shown verifies the fact that the market equilibrium (quantity) maximizes the sum of producer and consumer surplus.
201816141210865421020304050607080QuantityPriceSupplyDemandANS:
a. b. c. d. e. f. g. h. i.
40 $10.00 $80.00. 40 $5 $200
It would fall from $80 to only $20. It would fall from $120 to only $30.
At quantities less than the equilibrium quantity, the marginal value to buyers exceeds the marginal cost to sellers. Increasing the quantity in this region raises total surplus until equilibrium quantity is reached. At quantities greater than the equilibrium quantity, the marginal cost to sellers exceeds the marginal value to buyers and total surplus falls.
LOC: Supply and demand MSC: Analytical
DIF: 3 REF: 7-3 NAT: Analytic TOP: Consumer surplus | Producer surplus | Total surplus
Sec00 - Consumers, Producers, and the Efficiency of Markets
MULTIPLE CHOICE1.
Welfare economics is the study of how
a. the allocation of resources affects economic well-being. b. a price ceiling compares to a price floor. c. the government helps poor people.
d. a consumer’s optimal choice affects her demand curve.
DIF: 1 REF: 7-0 LOC: Supply and demand
ANS: A
NAT: Analytic MSC: Definitional
TOP: Welfare