BATARA, BRIEL ARNT C

BS BA-OM 1
MARKETS AND WELFARE

Consider a market in which Bert from Problem 3 is the buyer and Ernie from Problem 4 is the
seller.

a. Use Ernie's supply schedule and Bert's demand schedule to find the quantity sup-plied and
quantity demanded at prices of $2, $4, and $6. Which of these prices brings sup-ply and
demand into equilibrium?
b. What are consumer surplus, producer sur-plus, and total surplus in this equilibrium?
c. If Ernie produced and Bert consumed one fewer bottle of water, what would happen to total
surplus?
d. If Ernie produced and Bert consumed one additional bottle of water, what would hap-pen to
total surplus?

Price ($) Quantity Supplied by Price ($) Quantity Demanded

Ernie by Bert

$<1 4 bottles $<1 0 bottle

$2 3 bottles $2 1 bottle

$4 2 bottles $4 2 bottles

$6 1 bottle $6 3 bottles

$>7 0 bottles $>7 4 bottles

We can see from the table above that, at a price of $4, the amount required and the quantity
given are equal. As a result, $4 represents the market's equilibrium or clearing price. The
quantity that is demanded at this price is also the equilibrium quantity. As a result, the
equilibrium price is $4, and the equilibrium number of bottles is two.

Consumer surplus and production surplus are equal at equilibrium. Consequently, $4 would
represent the consumer and production surplus. Total surplus: The sum of all consumer and
producer surpluses at equilibrium;

Total surplus = Total Consumer Surplus + Total Producer Surplus

= $4+$4
= $8

If the production and consumption of water bottles are both reduced by one unit, then the
surplus for the consumer and producer is limited to the first bottle.

Consumer surplus on the first bottle = Value of First bottle - Equilibrium price
= $4 - $1
= $3
Therefore, the total surplus is;
Total surplus = Total Consumer Surplus + Total Producer Surplus
= $3+$3
= $6
Thus, The total surplus if one fewer is produced and consumed is $6

If one extra bottle is consumed and produced above the equilibrium quantity of two bottles and
price of $4 then both the consumer and producer surplus will decline.

Consumer surplus on third bottle = Value of third bottle - Equilibrium price

= $3 - $4
= -$1

Producer Surplus: Similarly, producer surplus also will be negative upon production of the third
bottle. The third bottle costs $5, but the price received on it will be only $4. Therefore, the
producer surplus will be negative on the third bottle

Producer surplus on third bottle = Equilibrium price - Cost of Third Bottle

= ($3+$1-$1)+($3+$1-$1)
= $6
Thus, the total surplus will be $6. Thus, the total surplus fell by $2.
If Ernie produced one additional bottle of water, his cost would be $5, but the
price is only $4, so his producer surplus would decline by $1. If Bert consumed
one additional bottle of water, his value would be $3, but the price is $4, so his
consumer surplus would decline by $1. So total surplus declines by $1 + $1 = $2

7. The cost of producing flat-screen TVs has fallen over the past decade. Let’s consider some
implications of this fact.

The effect of falling production costs in the market for flat-screen TVs results in a shift to
the right in the supply curve, as shown in the figure. As a result, the equilibrium price of
flat-screen TVs declines and the equilibrium quantity increases.

a. Draw a supply-and-demand diagram to show the effect of falling production costs on the price
and quantity of flat-screen TVs sold.

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

The decrease in the price of flat-screen televisions boosts consumer surplus from A to A
+ B + C +.D, a rise in the sum of B + C + D. Prior to the supply shift, producer excess was
concentrated in regions B and E (the above the supply curve but below the pricing).
Following the supply shift, the producer surplus is in regions E + F + G. As a result, the
producer surplus varies by the amount F + G - B, which might be positive or negative.
The A rise in quantity raises producer surplus, whereas a fall in price decreases
producer surplus. Total surplus grows because consumer surplus rises by B + C + D
and producer surplus rises by F + G - B.
by C, D, F, and G

c. Suppose the supply of flat-screen TVs is very elastic. Who benefits most from falling
production costs—consumers or producers of these TVs?
If the supply of flat-screen TVs 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 the figure. 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.

8. There are four consumers willing to pay the following amounts for haircuts:
Gloria: $35 Jay: $10 Claire: $40 Phil: $25
There are four haircutting businesses with the following costs:
Firm A: $15 Firm B: $30 Firm C: $20 Firm D: $10

Each firm has the capacity to produce only one haircut.

To achieve efficiency, how many haircuts should be given?
Which businesses should cut hair and which consumers should have their hair cut?
How large is the maximum possible total surplus?

shows supply and demand curves for haircuts. Supply equals demand at a quantity
of three haircuts and a price between $4 and $5. Firms A, C, and D should cut the hair of
Claire, Gloria, and Phil. Jay’s willingness to pay is too low and firm B’s costs are too
high, so they do not participate. The maximum total surplus is the area between the
demand and supply curves, which totals $11 ($8 value minus $2 cost for the first haircut,
plus $7 value minus $3 cost for the second, plus $5 value minus $4 cost for the third)

9. One of the largest changes in the economy over the past several decades is that
technological advances have reduced the cost of making computers.

a. Draw a supply-and-demand diagram to show what happened to price, quantity, consumer

surplus, and producer surplus in the market for computers.
Supply curve shifts to the right. The equilibrium price of computers declines and the
equilibrium quantity increases. Consumer surplus increases from A to (A + B + C + D).
Producer surplus increases by F + G – B (From B + E to E + F + G)

b. Forty years ago, students used typewriters to prepare papers for their classes; today they use
computers. Does that make computers and typewriters complements or substitutes? Use a
supply-and-demand diagram to show what happened to price, quantity, consumer surplus, and
producer surplus in the market for typewriters. Should typewriter producers have been happy or
sad about the technological advance in computers?

Typewriters and computers are substitutes. The decline in the price of computers means
that people substituted computers for typewriters, shifting the demand for typewriters to
the left, as shown in figure 15. The result is a decline in both the equilibrium price and
equilibrium quantity of typewriters. Consumer surplus in the typewriter market changes
from area A+B to A+C, a net change of C-B. Producer surplus changes from area C+D+E
to area E, a net loss of C+D. Typewriter producer are sad about technological advances
in computers because their producer surplus declines.

c. Are computers and software complements or substitutes? Draw a supply-and-demand

diagram to show what happened to price, quantity, consumer surplus, and producer surplus in
the market for software. Should software producers have been happy or sad about the
technological advance in computers?

Software and computers are computers are complements. When the price of computers
decreases, the demand for software increases. The demand for software shifts to the
right, as shown in figure 16. The result is an increase in both the price and quantity of
software. Consumer surplus in the software market changes from B+C to A+B, a net
change of A-C. Producer surplus changes from E to C+D+E, an increase of C+D, so
software producers should be happy about the technological progress in computers. (d)
Yes, this analysis helps explain why Bill Gates is one the world's richest people. His
company producers a lot of software and the producer surplus in the software market
increased with the technological advance in computers.

d. Does this analysis help explain why software producer Bill Gates is one of the world’s richest
people?

Yes, this analysis helps to explain why Bill Gates is one of the world's richest individuals,
because his firm generates a lot of software that is used in conjunction with computers,
and computers have advanced tremendously technologically.

10. A friend of yours is considering two cell phone service providers. Provider A charges $120
per month for the service regardless of the number of phone calls made. Provider B does not
have a fixed service fee but instead charges $1 per minute for calls. Your friend’s Copyright
2018 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in
whole or in part. WCN 02-200-203 152 PART III MARKETS AND WELFARE monthly demand
for minutes of calling is given by the equation QD 5 150 2 50P, where P is the price of a minute.

a. With each provider, what is the cost to your friend of an extra minute on the phone?

The cost of Provider A’s service is fixed at $120 per month. The total cost does not
depend upon the number of phone calls. Hence the cost of one extra minute on the
phone or the marginal cost(MC) is zero for provider A.
For provider B, the per minute price of calls is $1.
Therefore the cost of one extra minute of phone call from provider B is $1

b. In light of your answer to (a), how many minutes with each provider would your friend talk on
the phone?

Friend’s monthly demand for minutes of calling: QD =150-50P

At price $1 per minute, the number of minutes with Provider B that friend can
enjoy is, Q = 150 - 50*1 =100 minutes.
Since from provider A, the price of one extra minute of phone call is zero.
Given the demand, the total monthly number of minutes of phone call enjoyed by
friend is, Q =150 - 50*0 =150 minutes.
c. How much would she end up paying each provider every month?

The total monthly cost of the service of Provider A is $120.

Provider B charges $1 per minute of phone calls. The quantity demanded is 100 minutes
at this price.
Hence total monthly spending for services of Provider B = $1*100 = $100.

d. How much consumer surplus would she obtain with each provider? (Hint: Graph the demand
curve and recall the formula for the area of a triangle.)

e. Which provider would you recommend that your friend choose? Why?

provider A. Because the option offers more consumer surplus.