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P.S Week-5

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22 views5 pages

P.S Week-5

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akbarsaad49
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WEEK 5

Problem Set
Welfare and Efficiency

Part A: (MCQs AND FILL IN THE BLANKS)

1. Consumer surplus for a particular unit sold is equal to


a. the vertical distance between price and the demand curve. (answer)
b. the vertical distance between the demand curve and the supply curve.
c. the vertical distance between price and the supply curve.
d. the vertical distance between the demand curve and the x-axis.
e. the vertical distance between the supply curve and the x-axis

2. Market producer surplus is equal to what area?


a. The area below the demand curve but above price
b. The area between the demand and supply curves
c. The area below the demand curve but above the x-axis
d. The area above the supply curve but below price (ANSWER)
e. The area below the supply curve but above the x-axis

3. (a) The area above the supply curve but below price is known as ___producer
surplus_____________.
(b) The difference between a consumer’s maximum willingness to pay for something and
the price paid is known as _____consumer surplus_____________.

PART B:

4. Demand: P = 80 - 2Q
QD=(80-P)/2
Supply: P = 40 + 2Q
QS= (P-40)/2
where Q is the quantity of LCD screens and P is the dollar price per unit of LCD screen:

a. Given the above information, find the market equilibrium price and quantity. Find the
willingness to pay, economic cost/willingness to sell. Then calculate Consumer Surplus
(CS), Producer Surplus (PS) and Total Surplus (TS).

b. Suppose the government considers the LCD screen market as a potential government
income source and decides to impose a tax of $10 per screen.

Given this tax, find the new price that consumers will pay for a LCD screen in this
market, the new price producers will receive for a LCD screen in this market, and the
new equilibrium quantity of LCD screens that will be sold. Calculate the new CS, PS, TR,
and DWL.
(a) ANSWER: In equilibrium, we know that the quantity supplied equals the
quantity demanded. Set the demand equation equal to the supply equation:
80 - 2Q=40 + 2Q
4Q=40
Q*= 10 LCD Screens
By plugging this result back into either of two equations, we find the equilibrium
price
P*= 40 + 2Q= 40 + 2(10)= 60
Consumer’s willingness to pay:
P= 80 - 2(0)[Quantity = 0]
P= $ 80
Seller’s cost/willingness to sell:
P= 40 +2(0) [Quantity = 0]
P= $ 40
Consumer surplus is the area of the triangle above the price consumers pay, and
below the demand curve.
CS= 0.5x(80-60)x10= $ 100
Producer surplus is the area of the triangle below the price producers receive and
above the supply curve.
PS= 0.5x(60-40)x10= $ 100
Total Surplus= CS+PS=100+100= $ 200

(b) A tax of $10 per screen will be equally distributed among the buyers and
sellers i.e., 10/2= $ 5. The new price per screen paid by buyers will be (60+5=65)
$65 and the new price per screen received by sellers will be (60-5=55) $ 55.
QD= (80-P)/2= (80-65)/2= 7.5
QS= (P-40)/2= (55-40)/2= 7.5
So, Q*= 7.5

New CS= 0.5x(80-65)x7.5= $ 56.25


New PS= 0.5x(55-40)x7.5= $ 56.25
New TS= New CS + New PS= $ 56.25+ $ 56.25= $112.5
Tax revenue (TR)= (65-55)x7.5= $75 [Rectangle}
Deadweight loss (DWL)= [0.5x(65-60)x(10-7.5)]+[0.5x(60-55)x(10-7.5)]= 12.5 [2
Triangle]

5. There are six potential consumers of computer games, each willing to buy only one
game. Consumer 1 is willing to pay $40 for a computer game, consumer 2 is willing to
pay $35, consumer 3 is willing to pay $30, consumer 4 is willing to pay $25, consumer 5
is willing to pay $20, and consumer 6 is willing to pay $15.

a. Suppose the market price is $29. What is the total consumer surplus?
b. The market price decreases to $19. What is the total consumer surplus now?
(CS should increase)
ANSWER: a. Consumer surplus= willing to pay - amount paid
Consumers 4,5, and 6’s willingness to pay is lower than the price. So, they won’t
buy a game.
Consumer 1 buys a game since her willingness to pay is greater than the
Price. She gains $40 − $29 = $11.
Consumer 2 buys a game since his willingness to pay is greater than
the price. He gains $35 − $29 = $6.
Consumer 3 buys a game since her willingness to pay is greater than
the price. She gains $30 − $29 = $1.
The total consumer surplus is $11 + $6 + $1 = $18.

b. Consumer surplus= willing to pay - amount paid.


Now, all the consumer’s willingness to pay is greater than the price except for
consumer 6. So, each will buy a game except for consumer 6.
Consumer 1 buys a game since her willingness to pay is greater than
the price. She gains $40 − $19 = $21.
Consumer 2 buys a game since his willingness to pay is greater than
the price. He gains $35 − $19 = $16.
Consumer 3 buys a game since her willingness to pay is greater than
the price. She gains $30 − $19 = $11.
Consumer 4 buys a game since his willingness to pay is greater than
the price. He gains $25 − $19 = $6.

Consumer 5 buys a game since her willingness to pay is greater than the price.
She gains $20 − $19 = $1.
The total consumer surplus is $21 + $16 + $11 + $6 + $1 = $55.

6. Determine the amount of producer surplus generated in each of the following situations.

a. Gordon lists his old Lionel electric trains on eBay. He sets a minimum acceptable
price of $75. After five days of bidding, the final high bid is exactly $75. He accepts the
bid.

Ans a. Producer Surplus= amount received - cost (or willingness to sell)=


$75-$75=$0
Gordon will receive no producer surplus since the price received for the trains is
equal to his cost.
b. So-Hee advertises her car for sale in the used-car section of the student newspaper
and she is willing to sell the car for any price higher than $1,500. The best offer she get
is $1,200, which she declines.

Ans b. Producer Surplus= amount received - cost (or willingness to sell)=


$1200-$1500= -$300
No trade takes place because So-Hee’s cost is $1,500, which is higher than the
price of $1,200 she is offered. So no producer surplus is created.

c. (i) Sanjay likes his job so much that he would be willing to do it for free. However, his
annual salary is $80,000. He told his friend that his since economic cost is 0 therefore,
his producer surplus is:

Ans c. Producer Surplus= amount received - cost (or willingness to sell)=


$80,000-$0= $80,000
Sanjay’s cost is zero. The price he is paid for his time is $80,000, so his producer
surplus is $80,000.
(ii) However, his friend informed him that he is making a mistake in his
calculation. She said that he did not take into account the opportunity cost. If he
had worked those hours somewhere else he might have earned $20,000
annually. Therefore, his producer surplus would be:

Producer Surplus= amount received - cost (or willingness to sell)=


$80,000-$20,000= $60,000

Note: All these problems have been taken from external sources.

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