SFU Econ 103
Analytical questions Chapter 4
1. Suppose a little economy has ten people in it. Each person has a unit demand for cars, which means
that each person is willing to pay $ for one car, but zero for a second. The demands for each person
are given below in the table.
Person 1 2 3 4 5 6 7 8 9 10
$ (in 000’s) 20 30 40 20 60 10 50 70 5 30
a. Explain how each potential buyer determines willingness to pay for a good or service.
b. Construct two separate graphs that represent person 7’s demand and the entire market demand
for cars.
c. Now suppose that the market price for cars is $40,000. Which individual will buy a car? Explain
its underlying concept.
d. In part (c), given your answer, compute the total benefit and consumer surplus generated in this
market.
2. Assume the market price for lemongrass is $4.00 per pound, but most buyers are willing to pay more
than the market price. At the market price of $4.00, the quantity of lemongrass demanded is 1,500
pounds per month, and the quantity demanded does not reach zero until the price comes $30.00 per
pound. Construct a graph showing this data, calculate the total consumer surplus in the lemongrass
market, and show the consumer surplus on the graph. (Assume the demand is linear.)
3. What is the producer surplus? And how is the individual producer surplus measured?
4. The marginal cost for Java Joeʹs to produce its first cup of coffee is $0.75. Its marginal cost to produce
its second cup of coffee is $1.25. Its marginal cost increases by $0.50 for each additional cup of coffee
it produces. Suppose the market price for coffee is $2.00.
Construct a graph showing the producer surplus for each cup of coffee Java Joeʹs will sell. How many
cups of coffee will Java Joeʹs sell? What is the value of the producer surplus Java Joeʹs receives for each
cup of coffee it sells?
5. Will equilibrium in a market always result in an economically efficient outcome? Explain.
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SFU Econ 103
Analytical questions Chapter 4
6. Consider the diagram below showing market demand for and supply of a particular good.
a. Find the efficient equilibrium price and quantity in this market.
b. Compute the TB, TC, CS and PS at the equilibrium. Also, compute the total surplus (=TS) in two
different ways i) in terms of TB and TC, and ii) CS and PS.
c. Is the TS maximized at the market equilibrium? Explain what market condition leads to the
maximum TS.
d. Suppose the government eliminates this market. What will be the loss of social benefit?
e. What happens to market efficiency in this market if the market price is set at $15? Also, compute
the total surplus and Deadweight loss.
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SFU Econ 103
Analytical questions Chapter 4
Answers
Question 1
Part a)
A person's willingness to pay for a good or service shows the dollar value she or he attaches to it.
Willingness to pay for one more unit of a good is a dollar measure of the benefits of consuming the
extra unit of the good. As a result, the terms "willingness to pay" and "marginal benefit" are often
used interchangeably.
Part b)
Part c)
Person 3, 5, 7, and 8 only since willingness to pay for a car exceeds the price paid. Thus, those
consumers can have a positive net gain from the purchase of a vehicle.
Part d)
Person 1 2 3 4 5 6 7 8 9 10
WTP (in 000’s) 20 30 40 20 60 10 50 70 5 30
Net gain -20 -10 0 -20 +20 -30 +10 +30 -35 -10
Buy a car? No No Yes No Yes No Yes Yes No No
Total benefit = the sum of marginal benefits from those who actually purchased cars = 40 + 60 + 50
+ 70 = $220 in thousand
Consumer surplus = the sum of net gains = 0+ 20+ 10 + 30 = $60 in thousand
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SFU Econ 103
Analytical questions Chapter 4
Question 2
CS = (30-4)*1500 / 2 = $19,500 (measured
by the area under the demand curve and
above price.)
Question 3
Producer surplus (PS) in a market represents a total net gain to sellers from producing and selling
a good or service at a given market price. Individual PS is measured by the market price a firm
receives from the sale of a good or service minus its marginal costs.
Question 4
Java Joe will sell 3 cups of coffee,
the point where the market price
is higher or equal to its marginal
cost.
Quantity Price Marginal cost Surplus Sell coffee?
1 $2 $0.75 +$1.25 Yes
2 $2 $1.25 +$0.75 Yes
3 $2 $1.75 +$0.25 Yes
4 $2 $2.25 --------- No
Producer surplus $2.25
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SFU Econ 103
Analytical questions Chapter 4
Question 5
An economically efficient outcome means that total net gain or TS to participants (buyers and sellers)
in a market is maximized. A maximum TS is generated only at the equilibrium price at which the
marginal benefit of the last unit of output sold is equal to its marginal cost.
The TS is not maximized in markets if
✓ Markets are imperfectly competitive. ( i.e. only one seller or a few sellers in a market);
✓ there is the presence of any benefit or cost that private buyers and sellers do not consider
when market decisions are made; and
✓ improper management of resources (i.e. ill-defined property right or asymmetric
information)
Question 6
Part a)
P* = 10 and Q* = 4
Part b)
TB = the area under demand curve at Q* → (20+10)(4)/2 = $60
TC = the area under supply curve at Q* → (10)(4)/2 = $20
CS = the area under demand curve and above the price at Q* → (20-10)(4)/2 = $20
PS = the area under the price and above supply curve at Q* → (10)(4)/2 = $20
Total surplus TB – TC = $40, or CS +PS = $40.
Part c)
Yes, the TS is maximized in equilibrium at which MB = MC.
Part d)
Elimination of a market means that buyers and sellers no longer can trade for a specific good or
service. In other words, there will be no gains from trade, which is represented by the total surplus
lost. Thus, if this market is eliminated under government enforcement, the complete loss of total
surplus will be $40 that could have been gained from trade in a perfectly competitive market.
Part e)
If the price is $15, then there will be a surplus of 4 units where Qs is larger than Qd. Even though
6 units are supplied at this price, consumers desire to buy only 2 units. Thus, only 2 units will be
eventually sold and bought in this market. At Q of a good exchanged = 2, MB and MC are measured
$15 and $5, respectively. This means that an additional unit of a good or service exchanged will
increase net gain since additional benefit exceeds the extra cost. In other words, at Q=2, this
market fails to be efficient, thereby generating DWL.
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SFU Econ 103
Analytical questions Chapter 4
TB = the area under demand curve at Q = 2 → (20+15)(2)/2 = $35
TC = the area under supply curve at Q = 2 → (5)(2)/2 = $5
➔ TS = 35 – 5 = $30
The DWL is the loss in social total surplus so that it can be the difference between TS at Q* and
TS at Q =2.
DWL = TS at Q* - TS at Q=2 → $40 - $30 = $10
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