7-1a PDF - Consumer Surplus & Willingness to Pay

7-1a Tuesday, October 01, 2024 9:08 PM 1. Willingness to Pay: the maximum amount that a buyer is willing to pay for a good 2. Consumer surplus:the amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it 1. The table shows the demand schedule for the...

7-1a Tuesday, October 01, 2024 9:08 PM 1. Willingness to Pay: the maximum amount that a buyer is willing to pay for a good 2. Consumer surplus:the amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it 1. The table shows the demand schedule for the buyers (listed in Table 1) of the mint-condition copy of Elvis Presley’s first album. The graph shows the corresponding demand curve. The height of the demand curve reflects the buyers’ willingness to pay 2. 3. Marginal buyer- the buyer who would leave the market first if the price were any higher. At a quantity of 4 albums, for instance, the demand curve has a height of $500, the price that Karen (the marginal buyer) is willing to pay. At a quantity of 3 albums, the demand curve has a height of $700, the price that Mariah (now the marginal buyer) is willing to pay. of $500, the price that Karen (the marginal buyer) is willing to pay. At a quantity of 3 albums, the demand curve has a height of $700, the price that Mariah (now the marginal buyer) is willing to pay. In panel (a), the price of the good is $800, and consumer surplus is $200. In panel (b), the price is $700, and consumer surplus is $400 The area below the demand curve and above the price measures the consumer surplus in a market This is true because the height of the demand curve represents the value buyers place on the good, measured by their willingness to pay for it. The difference between this willingness to pay and the market price is each buyer’s consumer surplus. The area between the demand curve and the price line is the sum of the consumer surplus of all buyers in the market for a good or service. shows a typical demand curve. You may notice that it gradually slopes downward instead of taking discrete steps as in the previous two figures. In a market with many buyers, the resulting steps from each buyer dropping out are so small that they form a smooth demand curve. Although this curve has a different shape, the ideas we have just developed still apply: Consumer surplus is the area above the price line and below the demand curve. In panel (a), the price is , and consumer surplus is the area of triangle ABC. Now suppose that the price falls from to , as shown in panel (b). Consumer surplus equals area ADF. The increase in consumer surplus from the price cut is the area BCFD. This increase in consumer surplus has two parts. First, buyers who were already purchasing of the good at the higher price are better off because now they pay less. The increase in consumer surplus of existing buyers is the reduction in the amount they pay. It equals the area of the rectangle BCED. Second, some new buyers enter the market because they are willing to buy the good at the lower price, which increases the quantity demanded from to. The consumer surplus for the newcomers is the area of the triangle CEF. Imagine that you are a policymaker designing an economic system. Would you care about consumer surplus? Because it is the amount that buyers are willing to pay for a good minus the amount they actually pay for it, consumer surplus measures the benefit that buyers derive from a market as the buyers themselves perceive it. policymakers might choose to disregard consumer surplus because they do not respect the preferences that drive buyer behavior Cost- the value of everything a seller must give up to produce a good Producer surplus- the amount a seller is paid for a good minus the seller’s cost of  respect the preferences that drive buyer behavior Cost- the value of everything a seller must give up to produce a good Producer surplus- the amount a seller is paid for a good minus the seller’s cost of providing it Marginal seller-a seller who is willing to sell their products at the same price as their economic cost, and may be the first to leave the market if prices fall. The lesson from this example applies to all supply curves: The area below the price and above the supply curve measures the producer surplus in a market. Similarly, producer surplus is: Adding consumer and producer surplus together, we obtain: Here, the amount paid by buyers equals the amount received by sellers, so the middle two terms cancel each other. As a result: 1. Isabelle values her time at $60 an hour. She spends 2 hours giving Jayla a massage. Jayla was willing to pay as much as $300 for the massage, but they negotiated a price of $200. In this transaction, Answer a. consumer surplus is $20 larger than producer surplus. b. consumer surplus is $40 larger than producer surplus. c. producer surplus is $20 larger than consumer surplus. d. producer surplus is $40 larger than consumer surplus. 1. An efficient allocation of resources maximizes Answer a. consumer surplus. b. producer surplus. c. consumer surplus plus producer surplus. d. consumer surplus minus producer surplus.  Answer a. consumer surplus. b. producer surplus. c. consumer surplus plus producer surplus. d. consumer surplus minus producer surplus. 1. When a market is in equilibrium, the buyers are those with the willingness to pay, and the sellers are those with the costs. Answer a. highest; highest b. highest; lowest c. lowest; highest d. lowest; lowest 1. Producing a quantity larger than the equilibrium of supply and demand is inefficient because the marginal buyer’s willingness to pay is Answer a. negative. b. zero. c. positive but less than the marginal seller’s cost. d. positive and greater than the marginal seller’s cost. A tax on a good places a wedge between the price that buyers pay and the price that sellers receive. The quantity of the good sold declines. What about the third interested party, the government? If T is the size of the tax and Q is the quantity of the good sold, then the government takes in tax revenue of T × Q. What about the third interested party, the government? If T is the size of the tax and Q is the quantity of the good sold, then the government takes in tax revenue of T × Q. the government’s tax revenue is represented by the rectangle between the supply and demand curves. The height of this rectangle is the size of the tax, T, and its width is the quantity of the good sold, Q. Because a rectangle’s area is its height multiplied by its width, this rectangle’s area is T × Q, which equals the tax revenue.The tax revenue that the government collects equals T 3 Q, the size of the tax, T, times the quantity sold, Q. Thus, tax revenue equals the area of the rectangle between the supply and demand curves. Without a tax, the equilibrium price and quantity are found at the intersection of the supply and demand curves. The price is , and the quantity sold is. Because the demand curve reflects buyers’ willingness to pay, consumer surplus is the area between the demand curve and the price, A + B + C. Similarly, because the supply curve reflects sellers’ costs, producer surplus is the area between the supply curve and the price, D + E + F. Because there is no tax, tax revenue is zero. Total surplus, the sum of consumer and producer surplus, equals the area A + B + C + D + E + F. A tax on a good reduces consumer surplus (by the area B + C) and producer surplus (by the area D + E). Because the fall in producer and consumer surplus exceeds the tax revenue (area B + D), the tax is said to impose a Total surplus, the sum of consumer and producer surplus, equals the area A + B + C + D + E + F. A tax on a good reduces consumer surplus (by the area B + C) and producer surplus (by the area D + E). Because the fall in producer and consumer surplus exceeds the tax revenue (area B + D), the tax is said to impose a deadweight loss (area C + E). Welfare with a Tax Now consider welfare with a tax. The price paid by buyers rises from to , so consumer surplus equals only area A (the area below the demand curve and above the buyers’ price, ). The price received by sellers falls from to , so producer surplus equals only area F (the area above the supply curve and below the sellers’ price ). The quantity sold falls from to , and the government collects tax revenue equal to the area B + D. To find total surplus with the tax, add consumer surplus, producer surplus, and tax revenue. Thus, total surplus is area A + B + D + F. The table’s second producer surplus equals only area F (the area above the supply curve and below the sellers’ price ). The quantity sold falls from to , and the government collects tax revenue equal to the area B + D. To find total surplus with the tax, add consumer surplus, producer surplus, and tax revenue. Thus, total surplus is area A + B + D + F. The table’s second column summarizes these results. Changes in Welfare We can now see the effects of the tax by comparing welfare before and after the tax is enacted. The table’s third column shows the changes. Consumer surplus falls by the area B + C, and producer surplus falls by the area D + E. Tax revenue rises by the area B + D. Not surprisingly, with the tax, the buyers and sellers are worse off, and the government has more revenue. deadweight lossthe fall in total surplus that results from a market distortion As a result, the market shrinks below its optimum (as shown in the figure by the movement from to ). Thus, because taxes distort incentives, they cause markets to allocate resources inefficiently. When the government imposes a tax on a good, the quantity sold falls from to. At every quantity between and , the potential gains from trade among buyers and sellers are not realized. These lost gains from trade make up the deadweight loss. In panels (a) and (b), the demand curve and the size of the tax are the In panels (a) and (b), the demand curve and the size of the tax are the same, but the price elasticity of supply is different. Notice that the more elastic the supply curve, the larger the deadweight loss of the tax. In panels (c) and (d), the supply curve and the size of the tax are the same, but the price elasticity of demand is different. The more elastic the demand curve, the larger the deadweight loss of the tax. 2. If policymakers want to raise revenue by taxing goods while minimizing the deadweight losses, they should look for goods with elasticities of demand and elasticities of supply. Answer a. small; small b. small; large c. large; small d. large; large 1. In the economy of Agricola, tenant farmers rent the land they use. If the supply of land is perfectly inelastic, then a tax on land would have deadweight losses, and the burden of the tax would fall entirely on the. Answer a. sizable; farmers b. sizable; landowners c. no; farmers d. no; landowners 1. Suppose the demand for grape jelly is perfectly elastic (because strawberry jelly is a good substitute), while the supply is unit elastic.  a. sizable; farmers b. sizable; landowners c. no; farmers d. no; landowners 1. Suppose the demand for grape jelly is perfectly elastic (because strawberry jelly is a good substitute), while the supply is unit elastic. A tax on grape jelly would have deadweight losses, and the burden of the tax would fall entirely on the of grape jelly. Answer a. sizable; consumers b. sizable; producers c. no; consumers d. no; producers The deadweight loss is the reduction in total surplus resulting from the tax. Tax revenue is the size of the tax multiplied by the amount of the good sold. In panel (a), a small tax has a small deadweight loss and raises a small amount of revenue. In panel (b), a somewhat larger tax has a larger deadweight loss and raises more revenue. In panel (c), a very large tax has a very large deadweight loss, but because it reduces the size of the market so much, the tax raises only a small amount of revenue. Panels (d) and (e) summarize these conclusions. Panel (d) shows that as the size of a tax grows larger, the deadweight loss grows larger. Panel (e) shows that tax revenue first rises and then falls. This relationship is called the Laffer curve. 3. A tax on a good has a deadweight loss if Answer a. the reduction in consumer and producer surplus is greater than the tax revenue. b. the tax revenue is greater than the reduction in consumer and producer surplus. c. the reduction in consumer surplus is greater than the reduction in producer surplus. d. the reduction in producer surplus is greater than the reduction in consumer surplus. 1. Donna runs an inn and charges $300 a night for a room, which equals her cost. Sam, Harry, and Bill are three potential customers willing to pay $500, $325, and $250, respectively. When the government levies a tax on innkeepers of $50 per night of occupancy, Donna raises her price to $350. The deadweight loss of the tax is Answer a. $25. b. $50. c. $100. d. $150. 1. Sophie pays Sky $50 to mow her lawn every week. When the government levies a mowing tax of $10 on Sky, he raises his price to $60. Sophie continues to hire him at the higher price. What is the change in producer surplus, the change in consumer surplus, and the deadweight loss? Answer a. $0, $0, $10 b. $0, 2$10, $0 c. 1$10, 2$10, $10 d. 1$10, 2$10, $0 “A cut in federal income tax rates in the United States right now would lead to higher national income within five years than without the tax cut.”  d. 1$10, 2$10, $0 “A cut in federal income tax rates in the United States right now would lead to higher national income within five years than without the tax cut.” “A cut in federal income tax rates in the United States right now would raise taxable income enough so that the annual total tax revenue would be higher within five years than without the tax cut.” 4. The Laffer curve shows that, in some circumstances, the government can reduce a tax on a good and increase the Answer a. price paid by consumers. b. equilibrium quantity. c. deadweight loss. d. government’s tax revenue. 1. Eggs have a supply curve that is linear and upward-sloping and a demand curve that is linear and downward-sloping. If a 2 cent per egg tax is increased to 3 cents, the deadweight loss of the tax Answer a. increases by less than 50 percent and may even decline. b. increases by exactly 50 percent. c. increases by more than 50 percent. d. The answer depends on whether supply or demand is more elastic. 1. Peanut butter has an upward-sloping supply curve and a downward-sloping demand curve. If a 10 cent per pound tax is increased to 15 cents, the government’s tax revenue Answer a. increases by less than 50 percent and may even decline. b. increases by exactly 50 percent. c. increases by more than 50 percent. d. The answer depends on whether supply or demand is more  Answer a. increases by less than 50 percent and may even decline. b. increases by exactly 50 percent. c. increases by more than 50 percent. d. The answer depends on whether supply or demand is more elastic. The Equilibrium without International Trade When an economy cannot trade in world markets, the price adjusts to balance domestic supply and demand. This figure shows consumer and producer surplus in an equilibrium without international trade for the textile market in Isoland. world price-the price of a good that prevails in the world market for that good 5. The country of Autarka does not allow international trade. In Autarka, you can buy a wool suit for 3 ounces of gold, while in neighboring countries, the same suit costs 2 ounces of gold. This suggests that Answer a. Autarka has a comparative advantage in producing suits and would become a suit exporter if it opened up trade. b. Autarka has a comparative advantage in producing suits and would become a suit importer if it opened up trade. c. Autarka does not have a comparative advantage in producing suits and would become a suit exporter if it opened up trade. d. Autarka does not have a comparative advantage in producing suits and would become a suit importer if it opened up trade. 1. The nation of Openia allows free trade and exports steel. If steel exports  c. Autarka does not have a comparative advantage in producing suits and would become a suit exporter if it opened up trade. d. Autarka does not have a comparative advantage in producing suits and would become a suit importer if it opened up trade. 1. The nation of Openia allows free trade and exports steel. If steel exports were prohibited, the price of steel in Openia would be , benefiting steel. Answer a. higher; consumers b. lower; consumers c. higher; producers d. lower; producers International Trade in an Exporting Country Once trade is allowed, the domestic price rises to equal the world price. The supply curve shows the quantity of textiles produced domestically, and the demand curve shows the quantity consumed domestically. Exports from Isoland equal the difference between the domestic quantity supplied and the domestic quantity demanded at the world price. Sellers are better off (producer surplus rises from C to B + C + D), and buyers are worse off (consumer surplus falls from A + B to A). Total surplus rises by an amount equal to area D, indicating that trade raises the economic well-being of the country as a whole. International Trade in an Importing Country Once trade is allowed, the domestic price falls to equal the world price. The supply curve shows the amount produced domestically, and the demand curve shows the amount consumed domestically. Imports equal the difference between the domestic quantity demanded and the domestic quantity supplied at the world price. Buyers are better off (consumer surplus rises from A to A + B + D), and sellers are worse off (producer surplus falls from B + C to C). Total surplus rises by an amount equal to area D, indicating that trade raises the economic well-being of the country as a whole. The Effects of a Tariff A tariff, a tax on imports, reduces the quantity of imports and moves a market closer to the equilibrium that would exist without trade. Total surplus falls by an amount equal to area D + F. These two triangles represent the deadweight loss from the tariff. Import Quotas: Another Way to Restrict Trade  Import Quotas: Another Way to Restrict Trade Beyond tariffs, another way that nations sometimes restrict international trade is by putting limits on how much of a good can be imported. This book won’t analyze such a policy other than to point out the conclusion: Import quotas are much like tariffs. Both tariffs and quotas reduce the quantity of imports, raise the domestic price of a good, decrease the welfare of domestic consumers, increase the welfare of domestic producers, and cause deadweight losses. There is only one difference between these two types of trade restriction: A tariff raises revenue for the government, while an import quota generates surplus for those who obtain the permits to import. The profit for holders of import permits is the difference between the domestic price (at which they sell the imported good) and the world price (at which they buy it). Tariffs and import quotas are even more similar if the government charges a fee for these permits. Suppose the government sets the permit fee equal to the difference between the domestic and world price. In this case, the entire profit of permit holders is paid to the government in permit fees, and the import quota works exactly like a tariff. Consumer surplus, producer surplus, and government revenue are precisely the same under the two policies. In practice, however, countries that restrict trade with import quotas rarely do so by selling import permits. For example, the U.S. government has at times pressured Japan to “voluntarily” limit the sale of Japanese cars in the United States. In this case, the Japanese government allocates the import permits to Japanese firms, and these firms get the surplus from these permits. From the standpoint of U.S. welfare, this kind of import quota is worse than a U.S. tariff on imported cars. Both a tariff and an import quota raise prices, restrict trade, and cause deadweight losses, but at least the tariff generates revenue for the U.S. government rather than profit for foreign producers. Increased variety of goods. Goods produced in different countries are not exactly the same. German beer, for instance, is not the same as American beer. Free trade gives consumers in all countries a greater variety to choose from. Lower costs through economies of scale. Some goods can be produced at low cost only if they are produced in large quantities—a phenomenon called economies of scale. A firm cannot take full advantage of economies of scale if it can sell only in a small domestic market. Free trade gives firms access to  Free trade gives consumers in all countries a greater variety to choose from. Lower costs through economies of scale. Some goods can be produced at low cost only if they are produced in large quantities—a phenomenon called economies of scale. A firm cannot take full advantage of economies of scale if it can sell only in a small domestic market. Free trade gives firms access to world markets, allowing them to realize economies of scale more fully. Increased competition. A company shielded from foreign competitors is more likely to have market power, enabling it to raise prices above competitive levels. This is a type of market failure that hurts consumers and leads to inefficiencies. Opening trade fosters competition and gives the invisible hand a better chance to work its magic. Increased productivity. When a nation opens to international trade, the most productive firms expand their markets, while the least productive are forced out by increased competition. As resources move from the least to the most productive firms, overall productivity rises. Enhanced flow of ideas. The transfer of technological advances around the world is often linked to the exchange of the goods that embody those advances. The best way for a poor agricultural nation to quickly learn about the computer revolution, for instance, is to buy some computers from abroad rather than trying to make them from scratch. 6. When the nation of Ectenia opens to world trade in coffee beans, the domestic price falls. Which of the following describes the situation? Answer a. Domestic production of coffee rises, and Ectenia becomes a coffee importer. b. Domestic production of coffee rises, and Ectenia becomes a coffee exporter. c. a place where buyers meet and an auctioneer calls out prices. d. Domestic production of coffee falls, and Ectenia becomes a coffee importer. e. Domestic production of coffee falls, and Ectenia becomes a coffee exporter. 1. When a nation opens to trade in a good and becomes an importer, Answer a. producer surplus decreases, but consumer surplus and total surplus both increase. b. producer surplus decreases, but consumer surplus increases, so the impact on total surplus is ambiguous. c. producer surplus and total surplus increase, but consumer surplus decreases.  both increase. b. producer surplus decreases, but consumer surplus increases, so the impact on total surplus is ambiguous. c. producer surplus and total surplus increase, but consumer surplus decreases. d. producer surplus, consumer surplus, and total surplus all increase. 1. If a nation that imports a good imposes a tariff, it will increase Answer a. the domestic quantity demanded. b. the domestic quantity supplied. c. the quantity imported from abroad. d. the efficiency of the equilibrium. 1. Which of the following policies would benefit producers, hurt consumers, and increase the amount of trade? Answer a. the increase of a tariff in an importing country b. the reduction of a tariff in an importing country c. starting to allow trade when the world price is greater than the domestic price d. starting to allow trade when the world price is less than the domestic price 1. Which of the following policies would benefit producers, hurt consumers, and increase the amount of trade? Answer a. the increase of a tariff in an importing country b. the reduction of a tariff in an importing country c. starting to allow trade when the world price is greater than the domestic price d. starting to allow trade when the world price is less than the domestic price Chapter in a Nutshell The effects of free trade can be determined by comparing the domestic price before trade with the world price. A low domestic price indicates that the country has a comparative advantage in producing the good and that the country will become an exporter. A high domestic price indicates that the rest of the world has a comparative advantage in producing the good and that the country will become an importer. When a country allows trade and becomes an exporter of a good, producers of the good are better off, and consumers of the good are worse off. When a country allows trade and becomes an importer of a good, consumers are