Ch.15

NSS Exploring Economics 3 Chapter 15

Consumer surplus and producer surplus

Questions P.2

Think it over 1.

Do you know what the antique trader and the lady are doing in the diagrams? Why do they engage in such activity? 2.

What does the lady gain from buying the antique? 3.

What does the antique trader gain from selling the antique? 4.

Why do buyers and sellers usually bargain in the market? P.5

Test yourself 15.1

Fill in the blanks in the following table: Quantity (units / week)

Total benefit ($)

1

Marginal benefit ($)

10

2

9

3 4

Average benefit ($)

9 34

5

6

15.2

How can we find TB from AB? How can we find TB from MB? How can we find AB from TB? How can we find MB from TB?

NSS Exploring Economics 3

Questions and Answers Answers to Exercises (Chapter 15)

1

© Pearson Education Asia Limited 2010

P.7

Test yourself 15.3

Refer to Table 15.1 and Fig. 15.3. How many units of apples will Mary buy when the price is a.

$5;

b.

$4;

c.

$3;

d.

$2;

e.

$1?

15.4

What happens to a consumer’s maximum willingness to pay when his consumption of a good

increases? P.9

Test yourself 15.5

Assume the quantity a consumer can buy is continuous. Use a diagram to show how to find the total benefit from the marginal benefit curve graphically. 15.6

Calculate the consumer surpluses at different quantities demanded and complete the following table. Quantity Price ($)

demanded (units / week)

5

1

4

2

3

3

2

4

1

5

Total benefit b enefit

Total

Consumer

($)

expenditure ($)

surplus ($)

Discuss 15.1

Why are bookstores willing to sell textbooks to you?


Questions and Answers Answers to Exercises (Chapter 15)

2


P.13

Test yourself 15.7

Assume the fixed cost is $0. Fill in the blanks in the following table: Quantity (Q)

Total cost

Marginal cost

Average cost

(units / week)

(TC) ($)

(MC) ($)

(AC) ($)

1

3

2

5

3 4

5 24

5

11

15.8

How can we find TC from AC? How can we find TC from MC? How can we find AC from TC? How can we find MC from TC? 15.9

Refer to Table 15.2 and Fig. 15.8. How many units of apples will John produce when the price is a.

$1;

b.

$2;

c.

$3;

d.

$4;

e.

$5?

15.10

What happens to a producer’s minimum supply-price when his quantity supplied of a good increases?


Questions and Answers to Exercises (Chapter 15)

3


P.15

Test yourself 15.11

Using the data in Table 15.2, calculate the producer surpluses at different quantities supplied and complete the following table. Quantity

Price

supplied

($)

Total revenue

Total variable cost

Producer surplus

($)

($)

($)

(units / week)

1

1

2

2

3

3

4

4

5

5

15.12

Distinguish between the concepts of marginal benefit, market price and marginal cost. Discuss 15.2

Do bookstores gain from selling textbooks at the expense of consumers? Can both consumers and bookstores gain from the buying and selling of textbooks? P.18

Test yourself 15.13

Complete the following table. Quantity

MB

MC

1

$8

$1

2

$7

$2

3

$6

$3

4

$5

$5

5

$4

$8

(units / week)



MSS

4

TSS


P.21

Test yourself 15.14

Draw a diagram to show the effect of a decrease in demand on consumer surplus, producer surplus and total social surplus. Label the old and new consumer surplus, producer surplus and total social surplus. 15.15

Draw a diagram to show the effect of a decrease in supply on consumer surplus, producer surplus and total social surplus. Label the old and the new consumer surplus, producer surplus and total social surplus. P.23-26

Exercises Multiple Choice Questions 1.

The benefit of a good to a consumer is A. the maximum price he is willing to pay for the good. B. the price actually paid for the good. C. the maximum price he is willing to pay minus the price actually paid for the good. D. the same as the market price of the good. 2.

A person’s maximum willingness to pay for an additional unit of a good is termed

A. the total benefit. B. the average benefit. C. the marginal benefit. D. the market price. 3.

Marginal benefit of a good ______ when ______. A. increases … more is consumed B. remains the same … more is consumed C. decreases … more is consumed D. increases … marginal cost increases



5


4.

As long as the marginal benefit for a good is higher than its price, A. the consumer can enjoy a consumer surplus. B. the producer can enjoy a producer surplus. C. both the consumer and producer can gain from the exchange. D. the total social surplus will be maximised. 5.

Which of the following does one need to know before measuring the consumer surplus from a good? (1) The benefit of the good (2) The market price of the good (3) The quantity demanded of the good A. (1) and (2) only B. (1) and (3) only C. (2) and (3) only D. (1), (2) and (3) 6.

A used car is priced at $25,000 but John wants to pay no more than $20,000 for it. After negotiating with the seller, John gets the car at $19,000. His consumer surplus from the used car is A. $1,000. B. $5,000. C. $6,000. D. $19,000. 7.

Producer surplus is defined as A. the benefit of a good minus the price of the good. B. the price of a good minus the benefit of the good. C. the sum of the differences between price and marginal cost of a good for a given quantity. D. the cost of producing a good minus the price of the good.



6


8.

Paul asks his real estate agent to quote a price of $3.3 million for his flat. He also says that he will not sell his flat at a price lower than $3 million. Eventually, he sells his flat at $3.2 million. Paul earns a producer surplus of A. $100,000. B. $200,000. C. $300,000. D. $3,000,000. 9.

Which of the following statements about the above diagram is FALSE? A. Area A represents the consumer surplus. B. Area A + B represents the total social surplus. C. Area B + C represents the producer surplus. D. Area A + B + C represents the total benefit. Short Questions. 1.

Sue said, ‘The marginal benefit I receive from the last unit of a good must be the same as the price I actually pay for that unit of the good.’ Do you agree with Sue’s statement? Explain

your answer.

(3 marks)

2*.

Explain why the demand curve is the same as the consumers’ marginal benefit curve.

(3 marks) 3*. Explain why the supply curve is the same as the producers’ marginal cost curve.



7

(3 marks)


4

Below is information about a book. Suppose the most Peter is willing to pay to buy the book is the list price. List price

$100

Actual transaction price

10% discount

Variable cost

70% of the list price

a. What is the consumer surplus to Peter?

(3 marks)

b. What is the producer surplus to the seller?

(3 marks)

5.

Study the following table and answer the questions below. Quantity

Marginal

Marginal

benefit

cost

1

$10

$2

2

$8

$4

3

$6

$6

4

$4

$8

5

$2

$10

(units per week)

Marginal

Total

social

social

surplus

surplus

Consumer

Producer

surplus

surplus

a. What is the equilibrium price and the equilibrium quantity?

(2 marks)

b. Given the price is at the equilibrium level, complete the above table.

(4 marks)

Structured Questions. 1.

Assume that Hong Kong Disneyland has excess capacity during off-peak seasons. To increase the number of visitors, it offers an annual pass to visitors. A visitor can enter the theme park free of charge throughout the year after paying a lump-sum fee for the pass. a. Draw the supply curve for Hong Kong Disneyland.

(1 mark)

b. Explain why Hong Kong Disneyland has excess capacity during off-peak seasons in a supply-demand diagram.

(4 marks)

c*. Explain why the annual pass offer can increase the number of visits made by a visitor, as compared with a situation where the visitor needs to pay for each visit. Illustrate your answer with a supply-demand diagram. Label the horizontal axis as the number of visits. (4 marks) d**.Suppose that the total revenue received by Hong Kong Disneyland under the annual pass scheme from a visitor is the same as that under the pay-per-visit scheme. Use separate diagrams to compare the total benefit and consumer surplus under the two schemes.



8


(8 marks) e. There are higher-demand visitors and lower-demand visitors to Hong Kong Disneyland. Which group of visitors is more likely to buy the annual pass? Explain your answer. (4 marks) 2.

In the world oil market, extraction costs for crude oil (for each extra barrel) in different countries are not the same. Since there is a large oil reserve in Saudi Arabia, the extraction cost is much lower than many other countries such as China. However, all countries face the same market price of crude oil (per barrel) in the world market. a. What is producer surplus? Which country, Saudi Arabia or China, enjoys a larger producer surplus? Explain your answer.

(6 marks)

b. Explain why some countries import oil from other countries rather than extract oil from their oil wells.

(2 marks)

c*. The world demand for oil is increasing. Use a supply-demand diagram to show the effects on consumer surplus, producer surplus and total social surplus of an increase in world demand for oil.

(6 marks)

P.29

Test yourself 15.16

Draw three separate diagrams to show the effect of a decrease in demand and an increase in supply on the quantity transacted. (Hint: You may try it based on Fig.15.18) 15.17

Show that TSS will not change when the extent of increase in supply is the same as the extent of the decrease in demand. 15.18

Explain why TSS will increase when the increase in supply is greater than the decrease in demand. 15.19

Suppose demand increases but supply decreases. Show that TSS will decrease when the quantity transacted decreases. (Hint: You may use Fig. 15.19 and shift either D2 or S2 to the left.)



9


Answers P.2

Think it over 1.

Bargaining. To maximise their self-interest

2.

The extra amount she is willing to pay above what she actually pays

3.

The extra amount he actually receives above the minimum amount he must receive to sell the good Buyer: to lower the price paid

4.

Seller: to raise the price charged P.5

Test yourself 15.1

Quantity

Total benefit ($)

Marginal benefit ($)

Average benefit ($)

1

10

10 – 0 = 10

10 ÷ 1 = 10

2

10 + 9 = 19

9

19 ÷ 2 = 9.5

3

9 × 3 = 27

27 – 19 = 8

9

4

34

34 – 27 = 7

34 ÷ 4 = 8.5

5

34 + 6 = 40

6

40 ÷ 5 = 8

(units / week)

(Note that TB of the zero unit is $0.) 15.2

TB = AB × Q TB = ΣMB AB MB

TB 

Q

ΔTB 

ΔQ



10


P.7

Test yourself 15.3 a.

1 unit

b.

2 units

c.

3 units

d.

4 units

e.

5 units

15.4

A consumer’s maximum willingness to pay decreases. P.9

Test yourself 15.5

Since the sum of the marginal benefit is the total benefit, the total benefit is the area below the marginal benefit curve between 0 and the quantity demanded. $

TB MB 0

Q

Qd

15.6

Quantity Price ($)

demanded (units / week)

Total benefit

Total

Consumer

($)

expenditure ($)

surplus ($)

5

1

0+5=5

5×1=5

5 – 5 = 0

4

2

5+4=9

4×2=8

9 – 8 = 1

3

3

9 + 3 = 12

3×3=9

12 – 9 = 3

2

4

12 + 2 = 14

2×4=8

14 – 8 = 6

1

5

14 + 1 = 15

1×5=5

15 – 5 = 10

(Note that the price in each row = MB of the last unit of the corresponding quantity, and the TB of the zero unit is $0.)



11


Discuss 15.1

Because the price you pay for the textbooks is higher than the costs of supplying the textbooks. P.10 Speech bubble

Yes, because the price can cover the cost of producing it. P.13

Test yourself 15.7

Quantity (Q)

Total cost

Marginal cost

Average cost

(units / week)

(TC) ($)

(MC) ($)

(AC) ($)

1

3

3 – 0 = 3

3÷1=3

2

3+5=8

5

8÷2=4

3

3 × 5 = 15

15 – 8 = 7

5

4

24

24 – 15 = 9

24 ÷ 4 = 6

5

24 + 11 = 35

11

35 ÷ 5 = 7

15.8

TC = AC × Q TC = ΣMC + TFC AC MC

TC 

Q

ΔTC 

ΔQ

s

15.9 a.

1 unit

b.

2 units

c.

3 units

d.

4 units

e.

5 units

15.10

The producer’s minimum supply-price increases.



12


P.15

Test yourself 15.11

Quantity

Price

supplied

($)

Total revenue

Total variable cost

Producer surplus

($)

($)

($)

(units / week)

1

1

1×1=1

1

1 – 1 = 0

2

2

2×2=4

1+2=3

4 – 3 = 1

3

3

3×3=9

3+3=6

9 – 6 = 3

4

4

4 × 4 = 16

6 + 4 = 10

16 – 10 = 6

5

5

5 × 5 = 25

10 + 5 = 15

25 – 15 = 10

15.12

Marginal benefit is the maximum amount a consumer is willing to pay for an additional unit of a good. Market price is the amount a consumer has to pay for a unit of a good in the market. Marginal cost is the cost of producing an additional unit of a good. It is also the minimum amount a producer must receive to produce an additional unit of a good. Discuss 15.2

‘No’ for the first question and ‘yes’ for the second one.

As both consumers and bookstores voluntarily engage in the buying and selling of textbooks, they must expect a gain from the transactions. Consumers buy the books and gain from the exchange because the prices paid are lower than the maximum they are willing to pay. Bookstores gain because the prices received are higher than their costs of supplying the books. P.18

Test yourself 15.13

Quantity

MB

MC

MSS

TSS

1

$8

$1

$8 – $1 = $7

$0 + $7 = $7

2

$7

$2

$7 – $2 = $5

$7 + $5 = $12

3

$6

$3

$6 – $3 = $3

$12 + $3 = $15

4

$5

$5

$5 – $5 = $0

$15 + $0 = $15

5

$4

$8

$4 – $8 = $-4

$15 + ($-4) = $11

(units / week)



13


P.21

Test yourself 15.14

Old CS $ A

(Area AE1C)

S

B

E1

C F

Old PS

New PS

(Area CE10)

(Area FE20)

E2 D2

0 Old CS > New CS

∴CS

D1

Q

Old TSS

New TSS

(Area AE10)

(Area BE20)

decreases

Old PS > New PS ∴ PS decreases Old TSS (Area AE10) > New TSS (Area BE 20) ∴TSS decreases 15.15

S2

Old CS

New CS

(Area AE1C)

(Area AE2B)

S1 A B C

E2

Old PS (Area CE1F)

E1

F 0

Old CS > New CS

Q

∴CS

Old TSS

New TSS

(Area AE1F)

(Area AE2C)

decreases

Old PS > New PS ∴PS decreases Old TSS (Area AE1F) > New TSS (Area AE2C) ∴TSS decreases



14


P.23-26

Exercises Multiple Choice Questions 1.

A

2.

C

3.

C

4.

A.

Option B is incorrect. As long as the price is lower than the marginal cost, the producer cannot gain from the exchange, whether MB is higher than the price or not. Option C is incorrect. Both producers and consumers can gain from trade only if MB > P > MC. Option D is incorrect. If MB > P, an increase in consumption can increase CS and hence TSS. Therefore, TSS has not been maximised. 5.

D

6.

A

Consumer surplus = $20,000 – $19,000 = $1,000 7.

C

8.

B

Producer surplus = $3.2 million – $3 million = $200,000 9.

C

Producer surplus is Area B only. Area B + C is the total revenue or total expenditure. Short Questions. 1.

Agree.

Whenever MB ≥ P, a rational consumer will keep buying a good. Whenever MB < P, a

rational consumer will decrease his consumption. Therefore, given a decreasing MB curve, a rational consumer will increase her consumption until the marginal benefit for the last unit is equal to its price. (3 marks)



15


2.

Given the price of a good, we can find its quantity demanded from the MB curve by

finding the quantity where MB = P. Therefore, the MB curve is actually the demand curve, which relates price to quantity demanded. (3 marks) 3.

Given the price of a good, we can find its quantity supplied from the MC curve by

finding the quantity where MC = P. Therefore, the MC curve is actually the supply curve, which relates price to quantity supplied. (3 marks) 4 a. Consumer surplus = $100 – ($100 × 90%) = $10 (3 marks) b.

Producer surplus = ($100 × 90%) – ($100 × 70%) = $20

(3 marks)

5 a. $6 and 3 units (2 marks) b.

Quantity (units per

Marginal MB MC

social

week) 1

Total social

Consumer

Producer

surplus

surplus

surplus

surplus $10

$2

$10 – $2 =

$8

$10 – $6 × 1 =

$6 × 1 – $2 =

$4

$4

$8 + $4 =

($10 + $8) – $6

$6 × 2 – ($2 +

$12

× 2 = $6

$4) = $6

$12 + $0 =

($10 + $8 +

$6 × 3 – ($2 +

$12

$6) – $6 × 3 =

$4 + $6) = $6

$8 2 3

$8 $6

$4 $6

$8 – $4 = $4 $6 – $6 = $0

$6 4

5

$4

$2

$8

$4 – $8 =

$12 + (-$4)

($10 + $8 + $6

$6 × 4 – ($2 +

-$4

= $8

+ $4) – $6 × 4 =

$4 + $6 + $8) =

$4

$4

$8 + (-$8) =

($10 + $8 + $6

$6 × 5 – ($2 +

$0

+ $4 + $2) – $6

$4 + $6 + $8 +

× 5 = $0

$10) = $0

$10 $2 – $10 = -$8

(4 marks)



16


Structured Questions. 1 a.

$

S

No. of visitors

0

(1 mark)

b.

$ Excess capacity

S

P1

D (off-peak) 0

No. of visitors

(2 marks)

Hong Kong Disneyland has excess capacity during off-peak seasons because the demand is much lower during off-peak seasons and the price is set above the equilibrium level. (2 marks) c.

Suppose the original price for each visit is P1. After paying a lump sum fee for an annual

pass, a visitor need not pay any price for additional visits. Therefore, his price of additional visits becomes zero. He will visit Hong Kong Disneyland until his marginal benefit is equal to zero. His consumption will increase from Q1 to Qn. (2 marks)



17


$

P1 MB 0

Q1

Qn

No. of visits (2 marks)

The total benefit and consumer surplus will be larger under the annual pass scheme.

d.

$

$

TR = P1× Q1 (Unchanged) Total benefit = CS1 + CS2 + TR Consumer surplus = Total benefit – TR = CS1 + CS2

TR = P1× Q1 Total benefit = CS1 + TR Consumer surplus = CS1

CS1

CS1 P1 MB Q1

CS2 No. of visits

0

Under the pay-per-visit scheme

e.

(4 marks) TR

TR 0

P1

(4 marks)

Q1

MB Q2

No. of visits

Under the annual pass offer

A higher-demand visitor is more likely to buy the annual pass since the total benefit

from many visits is more likely larger than the lump sum fee for the annual pass. A lower-demand visitor may visit Hong Kong Disneyland once or twice a year, so the total benefit is more likely lower than the lump sum fee for the annual fee. (4 marks) 2. a. Producer surplus is the extra amount that a producer actually receives above the

minimum amount he must receive to produce a given quantity of a good. It is the difference between total revenue and total variable cost of production. (3 marks) Since the extraction cost of oil is much lower in Saudi Arabia, with the same market price, the country enjoys a larger producer surplus. (3 marks) b.

Because the price paid for imported oil is lower than the extraction cost of oil from their

domestic oil wells. (2 marks)



18


c.

$ A

S

B

E2

C F

Old CS

New CS

(Area BFE1)

(Area ACE2)

Old PS

New PS

(Area F0E1)

(Area C0E2)

E1 D1

0 Old CS < New CS

∴CS

D2

Q

Old TSS

New TSS

(Area BE10)

(Area AE20)

increases

Old PS < New PS ∴ PS increases Old TSS (Area BE10) < New TSS (Area AE20) ∴TSS increases

(6 marks)

P.29

Test yourself 15.16

$

S1

$

S2

S1

D1

D2

D2 Q

0

D1 Q

0

Q1 = Q2

Q2

(a) Quantity transacted remains

S2

Q1

(b) Quantity transacted when

unchanged when S = D

S < D

S1

$

S2

D2

0 Q1

D1

(c) Quantity transacted

Q

when S > D

Q2



19


15.17

$

S1 A

S = D Quantity transacted remains unchanged

S2

= B D2

0

=

D1

Total social surplus remains unchanged

Q

Q1 = Q2

15.18

As shown in Fig.15.21, when the increase in supply (from S1 to S2) is greater than the decrease in demand (from D1 to D2), the quantity transacted increases from Q1 to Q2. To explain the effect on TSS, we may just treat this situation as if the supply curve shifted twice: The supply curve shifts from S1 to S3 so that the quantity transacted remains Q1. As

•

shown in Fig.15.21, point A and point B will have the same TSS. The supply curve then shifts from S3 to S2. An increase in supply must lead to the

•

increases in quantity transacted and TSS (compare point B and point C). 15.19

S2

$

S1

B

The decrease in TSS

C

A  B: TSS remains unchanged B  C: TSS decreases A

∴WhenS

D3

quantity transacted  TSS

D2

0

D1 Q2 Q1



> D,

Q

20


D1 PS $ New (Area BE2C) Alternative answer: S2

$

S3 The decrease in TSS

S1

C B

A  B: TSS remains unchanged B  C: TSS decreases ∴WhenS

A

0

quantity transacted  TSS

D2 D1

Q2 Q1



> D,

Q

21


Ch.15

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