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Chapter7

Consumers,Producers,andtheEfficiencyofMarkets

TRUE/FALSE

1.Welfareeconomicsisthestudyofthewelfaresystem.

ANS:FDIF:1REF:7-1NAT:Analytic

LOC:SupplyanddemandTOP:WelfareMSC:Definitional

2.Thewillingnesstopayisthemaximumamountthatabuyerwillpayforagoodandmeasureshowmuchthebuyervaluesthegood.

ANS:TDIF:1

LOC:Supplyanddemand

MSC:Definitional

REF:7-1NAT:

TOP:Willingnesstopay

Analytic

3.Foranygivenquantity,thepriceonademandcurverepresentsthemarginalbuyer'swillingnesstopay.

ANS:TDIF:2

LOC:Supplyanddemand

MSC:Interpretive

REF:7-1NAT:

TOP:Willingnesstopay

Analytic

4.Abuyeriswillingtobuyaproductatapricegreaterthanorequaltohiswillingnesstopay,butwouldrefusetobuyaproductatapricelessthanhiswillingnesstopay.

ANS:FDIF:1

LOC:Supplyanddemand

MSC:Definitional

REF:7-1NAT:

TOP:Willingnesstopay

Analytic

5.Consumersurplusistheamountabuyeractuallyhastopayforagoodminustheamountthebuyeriswillingtopayforit.

ANS:FDIF:1

LOC:Supplyanddemand

MSC:Definitional

REF:7-1NAT:

TOP:Consumersurplus

Analytic

6.Consumersurplusistheamountabuyeriswillingtopayforagoodminustheamountthebuyeractuallyhastopayforit.

ANS:TDIF:1

LOC:Supplyanddemand

MSC:Definitional

REF:7-1NAT:

TOP:Consumersurplus

Analytic

7.Consumersurplusmeasuresthebenefittobuyersofparticipatinginamarket.

ANS:TDIF:1REF:7-1NAT:Analytic

LOC:SupplyanddemandTOP:Consumersurplus

MSC:Interpretive

8.Consumersurpluscanbemeasuredastheareabetweenthedemandcurveandtheequilibriumprice.

ANS:TDIF:1REF:7-1NAT:Analytic

LOC:SupplyanddemandTOP:Consumersurplus

MSC:Interpretive

9.Consumersurpluscanbemeasuredastheareabetweenthedemandcurveandthesupplycurve.

ANS:FDIF:1REF:7-1NAT:Analytic

LOC:SupplyanddemandTOP:Consumersurplus

MSC:Interpretive

10.Joelhasa1966Mustang,whichhesellstoSusie,anavidcarcollector.Susieispleasedsinceshepaid$8,000forthecarbutwouldhavebeenwillingtopay$11,000forthecar.Susie'sconsumersurplusis$2,000.

ANS:FDIF:1

LOC:Supplyanddemand

MSC:Interpretive

REF:7-1NAT:

TOP:Consumersurplus

Analytic

453

’.

;

11.IfDarbyvaluesasoccerballat$50,andshepays$40forit,herconsumersurplusis$10.ANS:TDIF:1REF:7-1NAT:AnalyticLOC:SupplyanddemandTOP:Consumersurplus

MSC:Applicative

12.IfDarbyvaluesasoccerballat$50,andshepays$40forit,herconsumersurplusis$90.

ANS:FDIF:1REF:7-1NAT:Analytic

LOC:SupplyanddemandTOP:Consumersurplus

MSC:Applicative

13.Allelseequal,anincreaseinsupplywillcauseanincreaseinconsumersurplus.

ANS:TDIF:2REF:7-1NAT:Analytic

LOC:SupplyanddemandTOP:Consumersurplus

MSC:Applicative

14.Supposethereisanincreaseinsupplythatreducesmarketprice.Consumersurplusincreasesbecause(1)consumersurplusreceivedbyexistingbuyersincreasesand(2)newbuyersenterthemarket.

ANS:TDIF:2

LOC:Supplyanddemand

MSC:Interpretive

REF:7-1NAT:

TOP:Consumersurplus

Analytic

15.Ifthegovernmentimposesabindingpricefloorinamarket,thentheconsumersurplusinthatmarketwillincrease.

ANS:FDIF:2

LOC:Supplyanddemand

MSC:Applicative

REF:7-1NAT:

TOP:Consumersurplus

Analytic

16.Ifthegovernmentimposesabindingpricefloorinamarket,thentheconsumersurplusinthatmarketwilldecrease.

ANS:TDIF:2

LOC:Supplyanddemand

MSC:Applicative

REF:7-1NAT:

TOP:Consumersurplus

Analytic

17.Eachsellerofaproductiswillingtosellaslongasthepriceheorshecanreceiveisgreaterthanthe

opportunitycostofproducingtheproduct.

ANS:TDIF:1

LOC:Supplyanddemand

MSC:Interpretive

REF:7-2NAT:

TOP:Opportunitycost

Analytic

18.Atanyquantity,thepricegivenbythesupplycurveshowsthecostofthelowest-costseller.ANS:FDIF:2REF:7-2NAT:AnalyticLOC:SupplyanddemandTOP:Opportunitycost

MSC:Interpretive

19.Inacompetitivemarket,salesgotothoseproducerswhoarewillingtosupplytheproductatthelowestprice.

ANS:TDIF:1REF:7-2NAT:Analytic

LOC:SupplyanddemandTOP:EfficiencyMSC:Interpretive

20.Producersurplusistheamountasellerispaidminusthecostofproduction.

ANS:TDIF:1REF:7-2NAT:Analytic

LOC:SupplyanddemandTOP:Producersurplus

MSC:Definitional

21.Producersurplusisthecostofproductionminustheamountasellerispaid.

ANS:FDIF:1REF:7-2NAT:Analytic

LOC:SupplyanddemandTOP:Producersurplus

MSC:Definitional

;

22.Allelseequal,anincreaseindemandwillcauseanincreaseinproducersurplus.

ANS:TDIF:2

LOC:Supplyanddemand

MSC:Applicative

REF:7-2NAT:

TOP:Producersurplus

Analytic

23.Allelseequal,adecreaseindemandwillcauseanincreaseinproducersurplus.

ANS:FDIF:2

LOC:Supplyanddemand

MSC:Applicative

REF:7-2NAT:

TOP:Producersurplus

Analytic

24.IfproducingasoccerballcostsJake$5,andhesellsitfor$40,hisproducersurplusis$45.

ANS:FDIF:1REF:7-2NAT:Analytic

LOC:SupplyanddemandTOP:Producersurplus

MSC:Applicative

25.IfproducingasoccerballcostsJake$5,andhesellsitfor$40,hisproducersurplusis$35.

ANS:TDIF:1REF:7-2NAT:Analytic

LOC:SupplyanddemandTOP:Producersurplus

MSC:Applicative

26.Conniecancleanwindowsinlargeofficebuildingsatacostof$1perwindow.Themarketpriceforwindow-cleaningservicesis$3perwindow.IfConniecleans100windows,herproducersurplusis$100.

ANS:FDIF:2

LOC:Supplyanddemand

MSC:Applicative

REF:7-2NAT:

TOP:Producersurplus

Analytic

27.Conniecancleanwindowsinlargeofficebuildingsatacostof$1perwindow.Themarketpriceforwindow-cleaningservicesis$3perwindow.IfConniecleans100windows,herproducersurplusis$200.

ANS:TDIF:2

LOC:Supplyanddemand

MSC:Applicative

REF:7-2NAT:

TOP:Producersurplus

Analytic

28.Theareabelowthepriceandabovethesupplycurvemeasurestheproducersurplusinamarket.

ANS:TDIF:2REF:7-2NAT:Analytic

LOC:SupplyanddemandTOP:Producersurplus

MSC:Interpretive

29.Theareabelowthedemandcurveandabovethesupplycurvemeasurestheproducersurplusinamarket.

ANS:FDIF:2REF:7-2NAT:Analytic

LOC:SupplyanddemandTOP:Producersurplus

MSC:Interpretive

30.Ifthegovernmentimposesabindingpriceceilinginamarket,thentheproducersurplusinthatmarketwillincrease.

ANS:FDIF:2

LOC:Supplyanddemand

MSC:Applicative

REF:7-2NAT:

TOP:Producersurplus

Analytic

31.Whendemandincreasessothatmarketpriceincreases,producersurplusincreasesbecause(1)producersurplusreceivedbyexistingsellersincreases,and(2)newsellersenterthemarket.

ANS:TDIF:2

LOC:Supplyanddemand

MSC:Interpretive

REF:7-2NAT:

TOP:Producersurplus

Analytic

32.Totalsurplusinamarketisconsumersurplusminusproducersurplus.

ANS:FDIF:1REF:7-3NAT:Analytic

LOC:SupplyanddemandTOP:Totalsurplus

MSC:Definitional

;

33.Totalsurplus=Valuetobuyers-Coststosellers.

ANS:TDIF:2

LOC:Supplyanddemand

MSC:Interpretive

REF:7-3

TOP:Totalsurplus

NAT:Analytic

34.Totalsurplusinamarketcanbemeasuredastheareabelowthesupplycurveplustheareaabovethedemandcurve,uptothepointofequilibrium.

ANS:FDIF:2

LOC:Supplyanddemand

MSC:Interpretive

REF:7-3

TOP:Totalsurplus

NAT:Analytic

35.ProducingasoccerballcostsJake$5.HesellsittoDarbyfor$35.Darbyvaluesthesoccerballat$50.Forthistransaction,thetotalsurplusinthemarketis$40.

ANS:FDIF:2

LOC:Supplyanddemand

MSC:Applicative

REF:7-3

TOP:Totalsurplus

NAT:Analytic

36.Theequilibriumofsupplyanddemandinamarketmaximizesthetotalbenefitstobuyersandsellersofparticipatinginthatmarket.

ANS:TDIF:2

LOC:Supplyanddemand

REF:7-3

TOP:Efficiency

NAT:

MSC:

Analytic

Interpretive

37.Efficiencyreferstowhetheramarketoutcomeisfair,whileequalityreferstowhetherthemaximumamountofoutputwasproducedfromagivennumberofinputs.

ANS:FDIF:1

LOC:Supplyanddemand

MSC:Definitional

REF:7-3NAT:

TOP:Efficiency|Equality

Analytic

38.Efficiencyisrelatedtothesizeoftheeconomicpie,whereasequalityisrelatedtohowthepiegetsslicedanddistributed.

ANS:TDIF:1

LOC:Supplyanddemand

MSC:Definitional

REF:7-3NAT:

TOP:Efficiency|Equality

Analytic

39.Freemarketsallocate(a)thesupplyofgoodstothebuyerswhovaluethemmosthighlyand(b)thedemandforgoodstothesellerswhocanproducethematleastcost.

ANS:TDIF:2REF:7-3NAT:Analytic

LOC:SupplyanddemandTOP:EfficiencyMSC:Interpretive

40.Economistsgenerallybelievethat,althoughtheremaybeadvantagestosocietyfromticket-scalping,thecoststosocietyofthisactivityoutweighthebenefits.

ANS:FDIF:2REF:7-3NAT:Analytic

LOC:SupplyanddemandTOP:EfficiencyMSC:Interpretive

41.Economistsarguethatrestrictionsagainstticketscalpingactuallydriveupthecostofmanytickets.

ANS:TDIF:2

LOC:Supplyanddemand

REF:7-3

TOP:Efficiency

NAT:

MSC:

Analytic

Interpretive

42.IftheUnitedStateslegallyallowedforamarketintransplantorgans,itisestimatedthatonekidneywouldsellforatleast$100,000.

ANS:FDIF:2

LOC:Supplyanddemand

MSC:Interpretive

REF:7-3

TOP:Efficiency

NAT:

|Equality

Analytic

43.Eventhoughparticipantsintheeconomyaremotivatedbyself-interest,the"invisiblehand"ofthe

marketplaceguidesthisself-interestintopromotinggeneraleconomicwell-being.

ANS:TDIF:2

LOC:Supplyanddemand

MSC:Interpretive

REF:7-3

TOP:Invisiblehand

NAT:Analytic

44.Thecurrentpolicyonkidneydonationeffectivelysetsapriceceilingofzero.

ANS:TDIF:2REF:7-3NAT:Analytic

LOC:SupplyanddemandTOP:EfficiencyMSC:Interpretive

45.Unlessmarketsareperfectlycompetitive,theymayfailtomaximizethetotalbenefitstobuyersandsellers.

ANS:TDIF:2REF:7-4NAT:Analytic

LOC:SupplyanddemandTOP:EfficiencyMSC:Interpretive

46.Inordertoconcludethatmarketsareefficient,weassumethattheyareperfectlycompetitive.

ANS:TDIF:2REF:7-4NAT:Analytic

LOC:SupplyanddemandTOP:EfficiencyMSC:Applicative

47.Marketswillalwaysallocateresourcesefficiently.

ANS:FDIF:2REF:7-4NAT:Analytic

LOC:SupplyanddemandTOP:EfficiencyMSC:Applicative

48.Whenmarketsfail,publicpolicycanpotentiallyremedytheproblemandincreaseeconomicefficiency.

ANS:TDIF:2REF:7-4NAT:Analytic

LOC:SupplyanddemandTOP:Marketfailure

MSC:Interpretive

49.Marketpowerandexternalitiesareexamplesofmarketfailures.

ANS:TDIF:2REF:7-4NAT:Analytic

LOC:SupplyanddemandTOP:Marketfailure

MSC:Interpretive

;

SHORTANSWER

1.Answereachofthefollowingquestionsaboutdemandandconsumersurplus.

a.Whatisconsumersurplus,andhowisitmeasured?

b.Whatistherelationshipbetweenthedemandcurveandthewillingnesstopay?

c.Otherthingsequal,whathappenstoconsumersurplusifthepriceofagoodfalls?Why?Illustrateusingademandcurve.

d.Inwhatwaydoesthedemandcurverepresentthebenefitconsumersreceivefromparticipatinginamarket?Inadditiontothedemandcurve,whatelsemustbeconsideredtodetermineconsumersurplus?

ANS:

a.Consumersurplusmeasuresthebenefittobuyersofparticipatinginamarket.Itismeasuredastheamountabuyeriswillingtopayforagoodminustheamountabuyeractuallypaysforit.Foranindividualpurchase,consumersurplusisthedifferencebetweenthewillingnesstopay,asshownonthedemandcurve,andthemarketprice.Forthemarket,totalconsumersurplusistheareaunderthedemandcurveandabovetheprice,fromtheorigintothequantitypurchased.

b.Becausethedemandcurveshowsthemaximumamountbuyersarewillingtopayforagivenmarketquantity,thepricegivenbythedemandcurverepresentsthewillingnesstopayofthemarginalbuyer.

c.Whenthepriceofagoodfalls,consumersurplusincreasesfortworeasons.First,thosebuyerswhowerealreadybuyingthegoodreceiveanincreaseinconsumersurplusbecausetheyarepayingless(areaB).Second,somenewbuyersenterthemarketbecausethepriceofthegoodisnowlowerthantheirwillingnesstopay(areaC);hence,thereisadditionalconsumersurplusgeneratedfromtheirpurchases.ThegraphshouldshowthataspricefallsfromP2toP1,consumersurplusincreasesfromareaAtoareaA+B+C.

d.Sincethedemandcurverepresentsthemaximumpricethemarginalbuyeriswillingtopayforagood,itmustalsorepresentthemaximumbenefitthebuyerexpectstoreceivefromconsumingthegood.Consumersurplusmusttakeintoaccounttheamountthebuyeractuallypaysforthegood,withconsumersurplusmeasuredasthedifferencebetweenwhatthebuyeriswillingtopayandwhathe/sheactuallypaid.Consumersurplus,then,measuresthebenefitthebuyerdidn'thaveto"payfor."

Price

A

P2

B

C

P1

DF

Q2

Q1

Demand

Quantity

DIF:TOP:

2REF:7-1

Consumersurplus

NAT:Analytic

MSC:Interpretive

LOC:Supplyanddemand

;

2.Tammylovesdonuts.ThetableshownreflectsthevalueTammyplacesoneachdonutsheeats:

Valueoffirstdonut

Valueofseconddonut

Valueofthirddonut

Valueoffourthdonut

Valueoffifthdonut

Valueofsixthdonut

$0.60

$0.50

$0.40

$0.30

$0.20

$0.10

a.UsethisinformationtoconstructTammy'sdemandcurvefordonuts.

b.Ifthepriceofdonutsis$0.20,howmanydonutswillTammybuy?

c.ShowTammy'sconsumersurplusonyourgraph.Howmuchconsumersurpluswouldshehaveatapriceof$0.20?

d.Ifthepriceofdonutsroseto$0.40,howmanydonutswouldshepurchasenow?WhatwouldhappentoTammy'sconsumersurplus?Showthischangeonyourgraph.

ANS:

a.1Price

0.9

0.8

0.7

0.6

0.5

0.4

0.3

0.2

0.1

Demand

12345678Quantity

b.Atapriceof$0.20,Tammywouldbuy5donuts.

c.ThefigurebelowshowsTammy'sconsumersurplus.Atapriceof$0.20,Tammy'sconsumersurpluswouldbe$1.00.

Price

1

0.9

0.8

0.7

0.6

0.1

0.5

0.1

0.1

0.1

0.1

0.4

0.1

0.1

0.1

0.3

0.10.1

0.2

0.1

1234

Demand

5678

Quantity

d.Ifthepriceofdonutsroseto$0.40,Tammy'sconsumersurpluswouldfallto$0.30andshewould

purchaseonly3donuts.

;

Price1

0.9

0.8

0.7

0.6

0.1

0.5

0.10.1

0.4

0.3

0.2

0.1

12

Demand

345678

Quantity

DIF:

TOP:

2REF:7-1

Consumersurplus

NAT:Analytic

MSC:Applicative

LOC:Supplyanddemand

3.Answereachofthefollowingquestionsaboutsupplyandproducersurplus.

a.Whatisproducersurplus,andhowisitmeasured?

b.Whatistherelationshipbetweenthecosttosellersandthesupplycurve?

c.Otherthingsequal,whathappenstoproducersurpluswhenthepriceofagoodrises?Illustrateyouransweronasupplycurve.

ANS:

a.Producersurplusmeasuresthebenefittosellersofparticipatinginamarket.Itismeasuredastheamountasellerispaidminusthecostofproduction.Foranindividualsale,producersurplusismeasuredasthedifferencebetweenthemarketpriceandthecostofproduction,asshownonthesupplycurve.Forthemarket,totalproducersurplusismeasuredastheareaabovethesupplycurveandbelowthemarketprice,betweentheoriginandthequantitysold.

b.Becausethesupplycurveshowstheminimumamountsellersarewillingtoacceptforagivenquantity,thesupplycurverepresentsthecostofthemarginalseller.

c.Whenthepriceofagoodrises,producersurplusincreasesfortworeasons.First,thosesellerswhowerealreadysellingthegoodhaveanincreaseinproducersurplusbecausethepricetheyreceiveishigher(areaA).Second,newsellerswillenterthemarketbecausethepriceofthegoodisnowhigherthantheirwillingnesstosell(areaB);hence,thereisadditionalproducersurplusgeneratedfromtheirsales.ThegraphshouldshowthataspricerisesfromP1toP2,producersurplusincreasesfromareaCtoareaA+B+C.

Price

Supply

P2

B

A

P1

C

G

D

Q1Q2Quantity

DIF:

TOP:

2REF:7-2

Producersurplus

NAT:Analytic

MSC:Interpretive

LOC:Supplyanddemand

4.Giventhefollowingequationstwoequations:

1)TotalSurplus=ConsumerSurplus+ProducerSurplus

2)TotalSurplus=ValuetoBuyers-CosttoSellers

Showhowequation(1)canbeusedtoderiveequation(2).

ANS:

Startwiththeequation:TotalSurplus=ConsumerSurplus+ProducerSurplus.Then,sinceConsumerSurplus=Valuetobuyers-Amountpaidbybuyers,andsinceProducerSurplus=Amountreceivedbysellers-Costsofsellers,thenTotalSurpluscanbewrittenas:Valuetobuyers-Amountpaidbybuyers+Amountreceivedbysellers-Costsofsellers.SincetheAmountpaidbybuyersequalstheAmountreceivedbysellers,themiddletwotermscanceloutandtheresultis:

TotalSurplus=Valuetobuyers-Costsofsellers.

DIF:

TOP:

2

Totalsurplus

REF:7-3

NAT:Analytic

MSC:Analytical

LOC:Supplyanddemand

;

5.AnswerthefollowingquestionsbasedonthegraphthatrepresentsJ.R.'sdemandforribsperweekofribsatJudy'sribshack.

a.Attheequilibriumprice,howmanyribswouldJ.R.bewillingtopurchase?

b.HowmuchisJ.R.willingtopayfor20ribs?

c.WhatisthemagnitudeofJ.R.'sconsumersurplusattheequilibriumprice?

d.Attheequilibriumprice,howmanyribswouldJudybewillingtosell?

e.HowhighmustthepriceofribsbeforJudytosupply20ribstothemarket?

f.Attheequilibriumprice,whatisthemagnitudeoftotalsurplusinthemarket?

g.Ifthepriceofribsroseto$10,whatwouldhappentoJ.R.'sconsumersurplus?

h.Ifthepriceofribsfellto$5,whatwouldhappentoJudy'sproducersurplus?

i.Explainwhythegraphthatisshownverifiesthefactthatthemarketequilibrium(quantity)maximizesthesumofproducerandconsumersurplus.

Price

20

18

16

14

Supply

12

10

8

6

5

4Demand

2

1020304050607080Quantity

ANS:

a.40

b.$10.00

c.$80.00.

d.40

e.$5

f.$200

g.Itwouldfallfrom$80toonly$20.

h.Itwouldfallfrom$120toonly$30.

i.Atquantitieslessthantheequilibriumquantity,themarginalvaluetobuyersexceedsthemarginalcosttosellers.Increasingthequantityinthisregionraisestotalsurplusuntilequilibriumquantityisreached.Atquantitiesgreaterthantheequilibriumquantity,themarginalcosttosellersexceedsthemarginalvaluetobuyersandtotalsurplusfalls.

DIF:3REF:7-3NAT:AnalyticLOC:Supplyanddemand

TOP:Consumersurplus|Producersurplus|TotalsurplusMSC:Analytical

Sec00-Consumers,Producers,andtheEfficiencyofMarkets

MULTIPLECHOICE

1.Welfareeconomicsisthestudyofhow

a.theallocationofresourcesaffectseconomicwell-being.

b.apriceceilingcomparestoapricefloor.

c.thegovernmenthelpspoorpeople.

d.aconsumer’soptimalchoiceaffectsedemandcurve.

ANS:A

NAT:Analytic

MSC:Definitional

DIF:

LOC:

1REF:7-0

Supplyanddemand

TOP:Welfare

desirable.

desirable.

2.Welfareeconomicsisthestudyof

a.taxesandsubsidies.

b.howtechnologyisbestputtouseintheproductionofgoodsandservices.

ernmentwelfareprogramsforneedypeople.

d.howtheallocationofresourcesaffectseconomicwell-being.

ANS:DDIF:1REF:7-0

NAT:AnalyticLOC:SupplyanddemandTOP:Welfare

MSC:Definitional

3.Welfareeconomicsisthestudyof

a.thewell-beingoflessfortunatepeople.

b.welfareprogramsintheUnitedStates.

c.howtheallocationofresourcesaffectseconomicwell-being.

d.theeffectofincomeredistributiononworkeffort.

ANS:CDIF:1REF:7-0

NAT:AnalyticLOC:SupplyanddemandTOP:Welfare

MSC:Definitional

4.Thestudyofhowtheallocationofresourcesaffectseconomicwell-beingiscalled

a.consumereconomics.

b.macroeconomics.

c.willingness-to-payeconomics.

d.welfareeconomics.

ANS:D

NAT:Analytic

MSC:Definitional

DIF:

LOC:

1REF:7-0

Supplyanddemand

TOP:Welfare

5.Anexampleofpositiveanalysisisstudying

a.howmarketforcesproduceequilibrium.

b.whetherequilibriumoutcomesarefair.

c.whetherequilibriumoutcomesaresocially

d.ifincomedistributionsarefair.

ANS:A

NAT:Analytic

MSC:Definitional

DIF:

LOC:

1REF:7-0

Supplyanddemand

TOP:Positivestatements

6.Anexampleofnormativeanalysisisstudying

a.howmarketforcesproduceequilibrium.

b.surplusesandshortages.

c.whetherequilibriumoutcomesaresociall

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