CH 6 Q&A W/ terms

Setting Maximum Prices

1.The government sets maximum prices, or price ceilings, in such markets as rental housing, gasoline (during the 1970s shortages), and medical care. 2.Maximum prices increase the quantity demanded and reduce the quantity supplied. 3.In these cases, the maximum price will cause excess demand and reduce the total surplus of the market.

Total Surplus Is Lower with a Price above the Equilibrium Price

1.Total surplus is lower at a minimum price above the equilibrium price because some mutually beneficial transactions do not take place. Specifically, some sellers could find buyers who would be willing to pay more than the marginal cost but less than the minimum price (the quantity demanded would be less than the quantity supplied). 2.This can occur if there is a price floor, a minimum price set by the government.

Refer to Figure 6.3. On this graph, area ABC is: a. consumer surplus. b. producer surplus. c. total surplus. d. total producer net benefit.

A Draw some lines on the graph and you shouldn't have difficulty convincing yourself that this is essentially the same as Figure 6.1 (although here we are assuming that the good is perfectly divisible).

Prices below the free market equilibrium are inefficient because the willingness to pay to someone from consuming an additional unit _________ the marginal cost to someone from producing that unit. a. exceeds b. is less than c. equals d. None of the above, efficiency defined in terms of natural resources, not market equilibrium

A Someone is willing to pay more than someone else would accept to provide the good. It would be inefficient to prevent them from making the transaction.

Suppose that the price of a bottle of soda is $1. Vonda's marginal cost is $1.25 for the first bottle, Galiela's marginal cost is $1.50 for the second bottle, Gretchen's marginal cost is $1.75 for the third bottle, and Matt's marginal cost is $2 for the fourth bottle. In equilibrium, what is the producer surplus from the marginal bottle of soda? a. $0 b. $0.25 c. $0.75 d. $1

A This is kind of a trick question. No one is willing to supply soda at the prevailing price.

Refer to Figure 6.3. On this graph, area ACD is: a. producer surplus. b. total surplus. c. consumer net benefit. d. consumer surplus.

B

A ban on imports will __________ the price domestic consumers pay for the good, and _________ the amount of the good consumed by domestic consumers. a. increase; increase b. increase; decrease c. decrease; increase d. decrease; decrease

B Basically the same as 14

Suppose that the price of a box of shotgun shells is $5. Morris' marginal cost of producing boxes of shotgun shells is $3.50 for the first box, Tommy's marginal cost of producing boxes of shotgun shells is $4 for the second box, Pat's marginal cost of producing boxes of shotgun shells is $5.50 for the third box, and Al's marginal cost of producing boxes of shotgun shells is $6 for the fourth box. In equilibrium, what is the producer surplus from the producing boxes of shotgun shells? a. $1.50 b. $2.50 c. $3.50 d. $4

B Basically the same as 2, the answer is $1.50 + $1.00 = $2.50.

Refer to Table 6.1. When quantity = 7, this market is ______________ because ______________. a. inefficient; willingness to pay > marginal cost b. inefficient; willingness to pay < marginal cost c. efficient; willingness to pay = marginal cost d. producing too much consumer surplus; willingness to pay > marginal cost

B Because the suppliers are not willing to supply the 7th good at the price the consumer is willing to pay for it.

A ban on imports will __________ the number of jobs in the domestic industry, and _________ the total surplus in the domestic market. a. increase; increase b. increase; decrease c. decrease; increase d. decrease; decrease

B The domestic firms do not have to compete with foreign markets so they can expand to meet the domestic demand but the lower supply will cause an increase an price ==> less consumer surplus. We pay more for many food products because we don't import sugar from Cuba. This is also why you see corn syrup used in so many products { it is sometimes used as a substitute for sugar.

A tax on a good will primarily be paid by consumers a. if the demand elasticity is much larger than the supply elasticity. b. if the supply elasticity is much larger than the demand elasticity. c. in all cases. d. in no cases.

B Very important question. See Figs. 7.9 and 7.10 in text. In 7.10a, the supply elasticity is much greater than the demand elasticity, so consumers pay most of the tax, whereas in 7.10b the pattern is the reverse. In fact, if demand is perfectly inelastic, consumers always pay all the tax, which is very intuitive.

If the government imposes a maximum price on rental apartments that is below the equilibrium price, we can expect to see all of the following except a. landlords doing less maintenance to their rental units. b. new apartment units being built. c. renters spending more time searching for apartments. d. some building owners converting their apartments to condominiums.

B Why build new apartments? Really this is assuming that the opportunity cost of building new apartments is greater than the revenue earning from renting one.

Producer surplus is defined as: a. the difference between the highest price consumers are willing to pay for a product and the minimum amount producers are will to accept for that product. b. the difference between the highest price consumers are willing to pay for a product and the actual price they are willing to pay. c. the difference between the price a producer receives for a product and the minimum amount a producer is willing to accept for that product. d. the economic profit earned from the sale of good, minus its marginal cost of production.

C

Consumer surplus refers to a. the cost of producing a unit of the product. b. the maximum that a consumer is willing to pay for the product. c. the difference between the price charged for the product and the cost of producing that product. d. the difference between the maximum that a consumer is willing to pay for a product and the price that is paid for the product.

D

What happens to consumer surplus as price falls on a particular demand curve? a. it decreases b. it decreases a very small bit c. it remains constant d. it increases

D In the above example, if the price fell to $0.75 Holly would buy the good but would not receive any consumer surplus (since her willingness to pay is exactly the marginal cost) but each of Larry, Alan and Ryan would get $0.25 extra in consumer surplus.

Suppose that the price of a bottle of soda is $1 each. Larry is willing to pay $2 for the first bottle, Alan is willing to pay $1.50 for the second bottle, Ryan is willing to pay $1.25 for the third bottle, and Holly is willing to pay $0.75 for the fourth bottle. What is the total consumer surplus from the consumption of soda? a. $6.50 b. $5.50 c. $2.75 d. $1.75

D The total consumer surplus is the sum of the difference between what people are willing to pay and what they actually have to pay. So in this case it is $1 (Larry) + $0.50 (Alan) + $0.25 (Ryan) = $1.75. Holly doesn't get any consumer surplus because she is not willing to buy the good at the current price.

Suppose that production of a good produces a negative spillover. A pollution tax equal to the spillover cost that decreases the quantity of good produced will result in all of the following except a. consumer surplus will decrease. b. producer surplus will decrease. c. output will decrease. d. society will be made worse off.

D This is a case where government action can make a market efficient. See chapters 9 and 10. The rub is that it is very difficult to measure the cost of pollution. One of the controversies in economics today concerns the 'double dividend hypothesis'. This says that if a pollution tax corrects for an inefficiency then why not raise the tax above the optimal level and use the extra revenue to reduce taxes that are distortionary. That is, set the tax at a level above the spillover cost but reduce other taxes such as sales taxes. So you get even less pollution and pay less taxes in other areas of the economy. Naysayers claim that raising the tax above the optimum level causes unemployment and/or reduced investment and thus, lowers overall welfare. In fact, the U.S. charges taxes (the taxes are levied on firms that produce petroleum and other chemicals) in order to finance the cleaning of Superfund sites (a daunting task), not to achieve efficiency at all but simply to finance the Superfund. It turns out that we charged other countries a higher tax than we charged domestic firms. This is a rather flagrant violation of the WTOs free trade policy and several countries, lead by Canada, disputed the higher tax. Amazingly, the U.S.'s defense was basically that it isn't that much higher so the other countries should not sweat it. The WTO ruled against us. You can read the settlement and all others here http://www.wto.org/english/tratop_e/dispu_e/distab_e.htm You should check out the dolphin safe tuna issue; the WTO came to an interesting conclusion there

Refer to Figure 6.3. On this graph, area BCEO represents a. producer surplus. b. total surplus. c. firm profits. d. total revenues.

D Total revenue is price times quantity. The market price occurs at B and the market quantity occurs at E. So total revenue is B£E, which is exactly the area of the rectangle BCEO.

The total burden of the tax on consumers will actually exceed the total amount of money the government collects.

Deadweight loss from taxation is the difference between the total burden of a tax and the amount of revenue collected by the government.

And backward onto input suppliers.

Firms will receive a lower price and will reduce the quantity, which will negatively affect input suppliers.

Efficiency and the Invisible Hand

Individual actions of buyers and sellers, each acting in his or her own self-interest, will bring the market to equilibrium and maximize the total surplus in the market.

Suppose that the supply of gasoline decreases. Price will __________ and consumer surplus will ______________. a. increase; increase b. increase; decrease c. decrease; increase d. decrease; decrease

Supply shifts back so price rises and therefore there is less consumer surplus

Government Intervention in Efficient Markets

The government may intervene in cases of market failure. This is a situation in which a market fails to be efficient because of external benefits, external costs, imperfect information, or imperfect competition. There are trade-offs associated with this government intervention and the various public policies. Some interventions bring the market closer to efficiency, and some take the market out of it.

Total Surplus Is Lower with a Price below the Equilibrium Price

Total surplus is lower at a maximum price below the equilibrium price because some mutually beneficial transactions do not take place. In other words, some sellers could find buyers who would be willing to pay a higher price than the maximum price (the quantity demanded would exceed the quantity supplied at that price). This can occur if there is a price ceiling, i.e., a maximum price set by the government.

The government sets maximum (ceiling) prices or minimum (floor) prices in certain markets;

both types of price setting reduce market efficiency. Market quotas and import restrictions also limit quantity and, thus, raise prices and cause market inefficiency.

Rent control generates a

deadweight loss, the decrease in the total surplus of the market that results from a policy such as rent control (as long as the maximum price is set below the equilibrium).

Because a tax causes people to change their behavior, the total burden of the tax

exceeds the revenue generated by the tax.

A tax on a good will be shifted

forward onto consumers...The price of the product will rise.

Consumer surplus

is the amount a consumer is willing to pay for a product minus the price the consumer actually pays.

Markets are inefficient when there are

possible beneficial transactions that are not completed due to government intervention, imperfect competition, or spillover benefits and costs.

Tax Shifting and the Price Elasticity of Demand: The amount of the tax shifted forward to consumers depends on the

price elasticity of demand for the taxed good.

The excess burden of taxes or deadweight loss from taxation comes about due to

the fact that people change their behavior to avoid taxation.

Producer surplus is

the price a producer receives for a product minus the marginal cost of production.

If a demand curve is elastic,

the price does not increase much, and consumers will not bear much of the tax. Hence the sellers will bear the tax.

If a demand curve is inelastic,

the price does rise a lot, and consumers will bear much of the tax. Hence the sellers will not bear the tax.

Market consumer surplus is

the sum of the consumer surplus for each consumer. You can also create this curve using students in your class.

Market producer surplus is

the sum of the producer surplus to each firm.

Where there are spillover costs,

too much will be produced because those costs are not taken into account. Government intervention can cause markets to be more efficient in this case.

An efficient market is one in which

total surplus is maximized.

The market equilibrium generates the highest possible

total surplus, i.e., the sum of consumer surplus and producer surplus.

The Supply Curve and Producer Surplus: Each point on the supply curve represents the seller's

willingness to accept, the minimum amount a producer is willing to accept as payment for a product; equal to the marginal cost of production. You can also create your own graph in the classroom.

The Demand Curve and Consumer Surplus: 1.Each point on the demand curve shows the buyer's

willingness to pay, the maximum amount a consumer is willing to pay for a product.

Efficiency is a situation in which people do the best they can, given their limited resources. A market equilibrium will generate the largest possible surplus and be efficient if the following conditions are met:

•No external benefits •No external costs •Perfect information •Perfect competition