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L11 - Consumer Demand Theory - 10162013.pdf

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James Pesando

Consumer Surplus = price buyer would be willing to pay less market price. Measures benefit to consumer of participating in a market Producer Surplus = market price less cost to seller Measures benefit to seller of participating in a market Allocatively efficient level of output : level of output where total surplus (consumer + producer) is maximized To left of QE, value to buyer > cost to sellers => efficient to increase output To right of QE, value to buyer < cost to sellers => efficient to reduce output If outputs less than competitive output: Value to buyer > Cost to seller (consumer + producer surplus) = total surplus would increase if output were increased Example (output < competitive output) Value to buyer = $100 Cost to seller = $60 Total surplus would increase by $40 if output increased by one Question: How much, in total, would consumers and reducers pay to prevent this market from shutting down? Answer: Consumer Surplus + Producer Surplus = Total Surplus Application / Review Your brother gives you a "frequent flier" coupon, which allows you to pay $200 less than the regular airfare on any flight you choose to take. The coupon can be used any time, and you often fly. The cost of Toronto/Vancouver airfare is $500 for a regular ticket. You value the trip from Toronto to Vancouver at $400. Should you use the coupon, pay $300, and fly to Vancouver? Explain your answer. Marginal Benefit of Trip: $400 Marginal Cost of Trip: $500 Why is marginal cost $500? $200 coupon has an opportunity cost of $200, since it can be used in other flights Result: Do NOT take trip Insight If coupon could only be sued on the Toronto/Vancouver trip, its opportunity cost would be zero and you should take the trip The government REMOVES a $10 sales tax that had been levied on sellers. TRUE OR FALSE If the market price does not change, we can conclude that the supply curve is perfectly elastic. Answer: False (Market price falls by $10) If P0 unchanged, DD must be perfectly elastic If Perfectly Elastic SS Market price falls by $10 True or False If DD is perfectly elastic, and there is a reduction in supply, consumer surplus will fall. False If DD is perfectly elastic, consumer surplus is zero If DD is perfectly elastic at price of $10, consumers would buy zero if the price were above $10.
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