Tutorial_6_solutions

1.An improvement in technology lowers the cost of producing DVD recorders. Explain what

happens to consumer surplus in the market for DVD recorders. Illustrate your answers with diagrams.

2.Suppose the demand for French bread rises. Explain what happens to producer surplus in the

market for French bread. Explain what happens to producer surplus in the market for flour.

Illustrate your answers with diagrams.

3.Regis is hungry for a snack. Here is the value he places on a cupcake:

Value of 1st cupcake $5

Value of 2nd cupcake $4

Value of 3rd cupcake $3

Value of 4th cupcake $2

a.From this schedule, derive Regis’ demand schedule. Graph his demand curve for

cupcakes.

b.If the price of a cupcake is $3.50, how many cupcakes does Regis buy? How much

consumer surplus does Regis get from his purchase? Show his consumer surplus in your

graph.

c.If the price falls to $2.50, how does quantity demanded change? How does Regis’

consumer surplus change? Show these changes in your graph.

4.The cost of producing stereo systems has fallen over the past several decades. Let’s consider

some implications of this fact.

a.Draw a supply-and-demand diagram to show the effect of falling production costs on the

price and quantity of stereo sold.

b.In your diagram, show what happens to consumer surplus and producer surplus.

c.Suppose the supply of stereos is very elastic. Who benefits most from falling production

costs – consumers or producers of stereos?

5.The supply and demand for ice cream cones are described by the following equations:

Supply: Q S = -30 + 38P

Demand: Q D = 90 – 2P

Q is the quantity of ice cream cones per day, and P is the price per cone (in dollars).

a.Graph the supply curve and the demand curve. What is the equilibrium price and

quantity?

b.Calculate consumer surplus, producer surplus, and total surplus at the equilibrium.

c.If a dictator who hated ice cream were to outlaw the sale of ice cream cones, who would

bear the larger burden – the buyers or the sellers of ice cream cones?

1. If there is an improvement in the technology of producing DVD recorders, the supply curve for DVD

recorders shifts to the right, as shown in Figure 1. The result is a fall in the price of DVD recorders and a rise in consumer surplus from A to A + B + C. So consumer surplus rises by the amount B + C.

2. A rise in the demand for French bread leads to an increase in producer surplus in the market for French

bread, as shown in Figure 2. The shift of the demand curve leads to an increased price, which increases producer surplus from area A to area A + B + C.

Figure 2.

The increased quantity of French bread being sold increases the demand for flour, as shown in Figure 3. As a result, the price of flour rises, increasing producer surplus from area D to D + E + F. Note that an event that affects producer surplus in one market leads to effects on producer surplus in related markets.

P r i c e o f D V D r e c o r d e r s

Quantity of DVD recorders

Figure 3.

3.

a.Regis’s demand schedule is:

Price Quantity Demanded

More than $5 0

$4 to $5 1

$3 to $4 2

$2 to $3 3

$2 or less 4

Regis’s demand curve is shown in Figure 4.

Figure 4.

b.When the price of a cupcake is $3.50, Regis buys two cupcakes. His consumer surplus is shown as

area A in the figure. He values his cupcake at $5, but pays only $3.50 for it, so he has consumer surplus of $1.50. He values his second cupcake at $4, but pays only $3.50 for it, so he has consumer surplus of $0.50. Thus Regis’s total consumer surplus is $1.50 + $0.50 = $2, which is the area of A in the figure.

c. When the price of a cupcake falls from $3.50 to $2.50, Regis buys three cupcakes, an increase of one.

His consumer surplus consists of both areas A and B in the figure, an increase in the amount of area B.

He gets consumer surplus of $2.50 from the first cupcake ($5 value minus $2.50 price), $1.50 from the

second cupcake ($4 value minus $2.50 price), and $0.50 from the third cupcake ($3 value minus $2 price), for a total consumer surplus of $4.50. Thus consumer surplus rises by $2.50 (which is the size of area B) when the price of a cupcake falls from $3.50 to $2.50.

4.

a. The effect of falling production costs in the market for stereos results in a shift to the right in the

supply curve, as shown in Figure 5. As a result, the equilibrium price of stereos declines and the equilibrium quantity increases.

b. The decline in the price of stereos increases consumer surplus from area A to A + B + C + D, an

increase in the amount B + C + D. Prior to the shift in supply, producer surplus was areas B + E (the area above the supply curve and below the price). After the shift in supply, producer surplus is areas E + F + G. So producer surplus changes by the amount F + G – B, which may be positive or negative.

The increase in quantity increases producer surplus, while the decline in the price reduces producer surplus. Because consumer surplus rises by B + C + D and producer surplus rises by F + G – B, total surplus rises by C + D + F + G.

Figure 5.

c. If the supply of stereos is very elastic, then the shift of the supply curve benefits consumers most. To

take the most dramatic case, suppose the supply curve were horizontal, as shown in Figure 6. Then

there is no producer surplus at all. Consumers capture all the benefits of falling production costs, with consumer surplus rising from area A to area A + B.

Figure 6.

5.

a. The supply and demand curves are shown in Figure 7. The equilibrium price and quantity are found

by equating quantity demanded and quantity supplied:

38P – 30 = 90 – 2P

40P = 120

P = $3.00

Q = 84

The equilibrium price is $3 per ice cream cone and the equilibrium quantity is 84 cones.

Figure 7.

b. At the market equilibrium, consumer surplus is equal to 0.5?($45 – $3)?84 = 0.5?(42$)?84 =

$1,764. Producer surplus at market equilibrium is 0.5?($3 – $0.79) ?84 =0.5? ($2.21) ?84 = $92.82.

Therefore, total surplus is $1,764 + $92.82 = $1,856.82.

c. If a dictator banned the sale of ice cream cones, producer and consumer surplus would both fall to $0.

Buyers would be harmed more than sellers would because the decline in consumer surplus would be greater than the decline in producer surplus.