ECON CHAPTER 4

(LC 4) Markets are efficient when:

they generate the largest possible amount of net benefits to all parties involved. Markets are efficient when the sum of consumer surplus and producer surplus is maximized.

(LC 4) If Brad buys a textbook costing $100 for which he is willing to pay $110, then his consumer surplus is:

$10 customer surplus= WTP-price

(LC 4) Total surplus is a measure of the net benefits _____ achieve(s) when both consumers and producers are valued components of an economy.

society

(HW 4) Market failure occurs when external benefits but not when external costs are present

FALSE

(LC 4) demand price above the equilibrium leads to..

a surplus

(LC 4) Competitive markets tend to have many buyers and ____ seller(s).

many

(HW 4) DWL in widgets and gizmos Ministry of Misallocation

widgets: $1000 gizmos: $80,000 Deadweight loss measures lost welfare when resources are misallocated to either over- or underproduce a good. If the good is underproduced, there are losses to both producer and consumer surplus, measured as the area between the supply and demand curves from the actual level of output to the equilibrium level of output. Overproduction means that, for units beyond the equilibrium quantity, consumers would have preferred something else that could have been produced with the resources used to produce the good. Society is producing a good at a cost that exceeds the value placed on the good. The measurement is the same, except the triangle is to the right of the equilibrium point. The widgets' deadweight loss, DLw , is found using the given equation. This equation uses the absolute values of these differences because the issue at hand is the distance between the curves and the quantities, not whether they are positive or negative. area of a triangle=base×height2 DLw=|4−6|×|4,000−3000|2=1000 For gizmos, the deadweight loss, DLg , is DLg=|80−40|×|8000−12000|2=80000

(LC 4) If Dan buys three hard drives for $50 apiece and he is willing to pay $50 apiece for them, what is his consumer surplus?

$0 W.T.P-price= customer surplus

(LC 4) Suppose Futurebook Co.'s willingness-to-sell for an e-reader is $50 and the firm has $57 of producer surplus. What is the market price of the tablet?

$107 57+50=107

(LC 4) Suppose the price of a tablet is $179. Ereaders Inc. produces tablets and has no producer surplus. How much is Ereaders Inc.'s willingness-to-sell?

$179 If the firm's willingness-to-sell is equal to the market price, the firm will sell the product but will not earn any producer surplus.

(HW 4) Market failure occurs when a free market provides a suboptimal quantity of goods and services.

TRUE

(LC 4) Suppose the price of a good in a market with three customers is $200. The first customer is willing to pay $200. The second customer is willing to pay $205. The total consumer surplus in the market is $15. How much is the third customer willing to pay?

$210 Consumer Surplus = Willingness-to-pay − Price. The first customer has no consumer surplus; the second customer has $5 of consumer surplus, and the third customer has $10 of consumer surplus. So the third customer's willingness-to-pay is Price + Consumer Surplus = $200 + $10 = $210.

(LC 4) Suppose the price of a tablet is $99 and there are three suppliers of tablets. Kimdle Co. is willing to sell the tablet for $79, Maxis Tech is willing to sell the tablet for $99, and the producer surplus in the market is $30. For how much is Dexus Co. willing to sell the tablet?

$89 Producer Surplus = Price − Willingness-to-sell. In this case, Kimdle Co. has $20 worth of producer surplus, and Maxis Tech has no producer surplus. The total producer surplus is $30 = Kimdle's PS + Dexus's PS. Therefore, Dexus's producer surplus would be $10, and its willingness-to-sell would be $99 - $10 = $89.

(LC 4) The figure shows a market for kayaks with an equilibrium price of $300. Suppose that the price for kayaks is set at $200. Which of these statements is FALSE?

Area A + B + C + D + F represents consumer surplus. Only 10,000 kayaks will be sold in the market. Area C + F represents a deadweight loss. The consumer surplus is represented by the area A + B + D.

(LC 4) Suppose the price of a tablet is $200. Alaya is willing to pay $200, Brit is willing to pay $210, and Jonah is willing to pay $300. How much consumer surplus is there in this market?

110 Consumer Surplus = Willingness -to-pay − Price. The consumer surplus in this market is ($200 - $200) + ($210 - $200) + ($300 - $200) = $0 + $10 + $100 = $110.

(HW 4) Consider the accompanying supply and demand graph. A: What is the value of consumer surplus? B: What is the value of producer surplus? C: What is the value of total (also called social or economic) surplus?

A: Consumer Surplus = (5 x $4.5) / 2 = $11.25 B:Producer Surplus = (5 x $3.5) / 2 = $8.75 C:Total Surplus = Consumer Surplus + Producer SurplusTotal Surplus = $11.25 + $8.75 = $20 Consumer surplus (CS) is the area below the demand curve and above the price line for all units consumed. Calculate the value of the CS by calculating the area of this triangle. The formula for the area of a triangle is 12𝑏ℎ, where 𝑏 is the length of the base, and ℎ is the height. CS=12(5−0)(9−4.5)=$11.25 Producer surplus (PS) is the area below the price line and above the supply curve for all units sold. Calculate the value of the PS by calculating the area of this triangle. PS=12(5−0)(4.5−1)=$8.75 Total surplus (TS) is the sum of CS and PS. TS=$11.25+$8.75=$20.00

(HW 4) The lease on Allison's apartment will expire next month, and she wants to move closer to campus. There are two apartments that she likes. Both are close to campus and in her price range. The first one is next door to a garage where local bands often practice late at night. The second one is next door to a donut shop that opens at 5 a.m. (A) If she likes to stay up late and loves listening to all kinds of music, she will view the bands practicing as a(n) (B) If she is a morning person and loves the smell of donuts, she will view the donut shop as a(n) (C) If her roommate hates loud music, and the smell of donuts makes her sick, she will reject both apartments due to what she sees as

A: external benefit B: external benefit C: external cost If Allison views the late-night band practices as a good thing, she is experiencing an external benefit. Although she is not involved in the practice, and she is not the intended audience, the music affects her. If she perceives the smell of donuts to be a good thing, she is experiencing an external benefit. The donuts are not produced for her consumption, but whether she goes next door and buys a donut or not, she still gets the benefit of yummy donut smells. Because her roommate thinks late-night bands and early-morning donuts are bad things, she is experiencing an external cost. Although she is not involved in the production of the music or the donuts, she is still affected.

(HW 4) Market failure occurs when external costs but not when external benefits are present

FALSE

Market failure can occur only in the presence of external costs.

FALSE One of the desirable characteristics of freely functioning markets is that they often lead to socially optimal outcomes. However, under certain conditions, markets fail to efficiently allocate resources, leading to socially undesirable outcomes. Markets that exhibit external costs or external benefits often fail to efficiently allocate resources. Most buyers and sellers of goods consider only private benefits and costs when making purchasing decisions and ignore external benefits and costs borne by others. All benefits and costs must be taken into account in order for a market to produce a socially optimal outcome. External costs and benefits are not the only sources of market failure. Other examples include public goods, asymmetric information, and monopolies. Governments often intervene in markets that have external costs or benefits, such as healthcare markets, education markets, and markets that produce environmental pollution.

(HW 4) Suppose that Michelle buys a cappuccino from Paul's Cafe and Bakery for $6.25. Michelle was willing to pay up to $7.75 for the cappuccino, and Paul's Cafe and Bakery was willing to accept $2.75 for the cappuccino. Based on this information, answer the following questions.

Michelle's consumer surplus: $1.50 Paul's Cafe and Bakery's producer surplus: $3.50 Consumer surplus is equal to the difference between the maximum amount that a consumer is willing to pay for an item and the price she pays for the item. In this problem, Michelle is willing to spend $7.75 on a cappuccino. However, she only needs to pay $6.25 to get it. Therefore, her consumer surplus is equal to consumer surplus=$(willingness to pay)−$(price)=$7.75−$6.25=$1.50 Producer surplus is equal to the difference between the lowest amount a seller is willing to accept for selling an item and the market price. In this problem, Paul's Bakery is willing to sell the cappuccino for $2.75. However, the bakery receives $6.25 when Michelle buys her drink. Therefore, the bakery's producer surplus is equal to producer surplus=$(price)−$(willingness to sell)=$6.25−$2.75=$3.50

(LC 4) Jerry and Anat each own a bicycle tire shop and sell bicycle tires. Suppose the equilibrium price for bicycle tires is $42 but the market price falls to $37. Neither is able to earn a profit at the lower price, and both go out of business. If there are no other sellers in this market, what effect does this have on producer surplus?

Producer surplus decreases to zero. Producers who exit the market no longer have any producer surplus

(LC 4) Which of the following statements is correct?

Public goods are nonrival and nonexclusive.

(HW 4) Market failure occurs when external costs or benefits are present.

TRUE

(HW 4) The government sometimes intervenes when market failure occurs.

TRUE

(HW 4) Teri takes her new puppy to the veterinarian. After he examines the puppy, the vet tells Teri that her puppy needs a series of shots. Teri agrees to the shots since the veterinarian knows way more about animal health than she does. This is an example of

This question illustrates the basic concept of asymmetric information. With asymmetric information, one party in a transaction has significantly better information than the other party. In this scenario, the veterinarian has many years of training and has much better information than Teri about the proper medical treatment that her puppy needs.

(LC 4) The figure shows a market for kayaks with an equilibrium price of $300. Which of these statements is FALSE?

When the market price decreases to $200, producer surplus is represented by the area D + F. This area is the loss in producer surplus.

(LC 4) The state of Florida caps the price of homeowners insurance. As a result, State Farm pulled out of the homeowners insurance market in Florida. What was the likely result of this binding price ceiling?

a shortage of homeowners insurance coverage When a price ceiling is set below the equilibrium, more homeowners want insurance, but fewer insurance companies want to provide it, and shortages result.

(HW 4) The graph shows the market for corn with a price ceiling of $7. Fill in the blanks with the correct terms and numbers. After the price ceiling is in place, how many bushels of corn are bought or sold? A: ______ bushels The market is not in equilibrium after the price ceiling is imposed. Rather, there is a B: ________of how many units? C: ______ bushels

a: 5 bushels b: shortage c: 5.86 bushels Because the price ceiling is set below the equilibrium price, it is a binding price control, and the price of corn becomes $7. The graph indicates that the sellers are willing to sell 5 bushels at this price, whereas the buyers are willing to buy 10.86 bushels. All transactions where both a willing buyer and a willing seller exist will take place. Therefore, 5 bushels are bought and sold. At $7, the quantity demanded (10.86 bushels) is greater than the quantity supplied (5 bushels). A shortage occurs when the supply is not enough to meet the demand. The amount of a shortage is the difference between the quantity demanded and the quantity supplied. 10.86 bushels−5 bushels= shortage of 5.86 bushels

(HW 4) Suppose that policy makers are concerned that the price of corn may get too low. The market for corn is depicted in the accompanying diagram. a. What type of price control would policy makers use to keep the price of corn from getting too low? b. Suppose that the government implements the price control that you have selected. Which of these prices would be binding?

a: price floor b: $7 To keep the price of corn from getting too low, policy makers would institute a price floor. A price floor is a legally set minimum price. A price control is binding if it impacts the market. A price floor of $6 or $5 would have no impact in this case because the equilibrium market price already conforms to it.

(HW 4) Producer surplus is shown graphically as the area

above the supply curve and below the market price. The price a firm receives for a product is generally above the price it is willing to accept (its marginal cost). The difference between these two is producer surplus—a measure of the net benefit a producer receives when it sells a product. The height of the supply curve represents the lowest price firms can accept for their product. The price they actually receive is the equilibrium or market price. Therefore, shown graphically, producer surplus is the area under the market price and above the supply curve.

(LC 4) Suppose the equilibrium price in a market is $10. The government sets a minimum price of $12. This price of $12 is an example of a(n):

binding price floor. A price floor is a minimum price established by the government for a good and is set above the equilibrium price.

(LC 4) The figure shows the market for portable DVD players. Assume the government sets a price ceiling at $40. This price ceiling will:

have no effect. The maximum price is the same as the market price, so the price ceiling does not cause any changes. The market will stay in equilibrium.

(LC 4) Increased demand has driven up helium prices dramatically over the past several years. Because of this, the cost of helium-filled birthday balloons has quadrupled. Who might benefit from this price increase?

helium producers still able to sell helium at the higher price A higher price benefits producers still able to sell the product.

(LC 4) A seller of a unique used car is the only one seller in the country. In this case, the market for this used car is likely to fail due to the:

lack of competition. This is because there is no other seller in the market; there is no competition.

(HW 4) Producer surplus is the difference between

the market price and the minimum price a seller is willing to accept.