Chapter 7/Consumers, Producers, and the Efficiency of Markets ? 457

44. The current policy on kidney donation effectively sets a price ceiling of zero.

ANS: T DIF: 2 REF: 7-3 NAT: Analytic LOC: Supply and demand TOP: Efficiency MSC: Interpretive

45. Unless markets are perfectly competitive, they may fail to maximize the total benefits to buyers and sellers.ANS: T DIF: 2 REF: 7-4 NAT: Analytic LOC: Supply and demand TOP: Efficiency MSC: Interpretive

46. In order to conclude that markets are efficient, we assume that they are perfectly competitive.ANS: T DIF: 2 REF: 7-4 NAT: Analytic LOC: Supply and demand TOP: Efficiency MSC: Applicative

47. Markets will always allocate resources efficiently.ANS: F DIF: 2 REF: 7-4 LOC: Supply and demand TOP: Efficiency

NAT: Analytic

MSC: Applicative

48. When markets fail, public policy can potentially remedy the problem and increase economic efficiency.ANS: T DIF: 2 REF: 7-4 NAT: Analytic LOC: Supply and demand TOP: Market failure MSC: Interpretive

49. Market power and externalities are examples of market failures.ANS: T DIF: 2 REF: 7-4 NAT: Analytic LOC: Supply and demand TOP: Market failure MSC: Interpretive

458 ? Chapter 7/Consumers, Producers, and the Efficiency of Markets SHORT ANSWER1.

Answer each of the following questions about demand and consumer surplus.

a. What is consumer surplus, and how is it measured?

b. What is the relationship between the demand curve and the willingness to pay?

c. Other things equal, what happens to consumer surplus if the price of a good falls? Why? Illustrate

using a demand curve.

d. In what way does the demand curve represent the benefit consumers receive from participating in a

market? In addition to the demand curve, what else must be considered to determine consumer surplus?

ANS:

a. Consumer surplus measures the benefit to buyers of participating in a market. It is measured as the

amount a buyer is willing to pay for a good minus the amount a buyer actually pays for it. For an individual purchase, consumer surplus is the difference between the willingness to pay, as shown on the demand curve, and the market price. For the market, total consumer surplus is the area under the demand curve and above the price, from the origin to the quantity purchased.

b. Because the demand curve shows the maximum amount buyers are willing to pay for a given

market quantity, the price given by the demand curve represents the willingness to pay of the marginal buyer.

c. When the price of a good falls, consumer surplus increases for two reasons. First, those buyers

who were already buying the good receive an increase in consumer surplus because they are paying less (area B). Second, some new buyers enter the market because the price of the good is now lower than their willingness to pay (area C); hence, there is additional consumer surplus generated from their purchases. The graph should show that as price falls from P2 to P1, consumer surplus increases from area A to area A+B+C.

d. Since the demand curve represents the maximum price the marginal buyer is willing to pay for a

good, it must also represent the maximum benefit the buyer expects to receive from consuming the good. Consumer surplus must take into account the amount the buyer actually pays for the good, with consumer surplus measured as the difference between what the buyer is willing to pay and what he/she actually paid. Consumer surplus, then, measures the benefit the buyer didn't have to \

PriceAP2BP1CDFDemandQ2Q1QuantityDIF: 2 REF: 7-1 TOP: Consumer surplus NAT: Analytic

MSC: Interpretive

LOC: Supply and demand

Chapter 7/Consumers, Producers, and the Efficiency of Markets ? 459

2.

Tammy loves donuts. The table shown reflects the value Tammy places on each donut she eats:

$0.60 $0.50 $0.40 $0.30 $0.20 $0.10 Value of first donut Value of second donut Value of third donut Value of fourth donut Value of fifth donut Value of sixth donut a. Use this information to construct Tammy's demand curve for donuts. b. If the price of donuts is $0.20, how many donuts will Tammy buy?

c. Show Tammy's consumer surplus on your graph. How much consumer surplus would she have

at a price of $0.20?

d. If the price of donuts rose to $0.40, how many donuts would she purchase now? What would

happen to Tammy's consumer surplus? Show this change on your graph.

10.90.80.70.60.50.40.30.20.1123456PriceANS:

a.

Demand78Quantityb. At a price of $0.20, Tammy would buy 5 donuts.

c. The figure below shows Tammy's consumer surplus. At a price of $0.20, Tammy's consumer surplus

would be $1.00.

10.90.80.70.60.50.40.30.20.11234560.10.10.10.10.10.10.10.10.10.1Price

Demand78Quantity

d. If the price of donuts rose to $0.40, Tammy's consumer surplus would fall to $0.30 and she would

purchase only 3 donuts.

460 ? Chapter 7/Consumers, Producers, and the Efficiency of Markets

10.90.80.70.60.50.40.30.20.11234560.10.10.1PriceDemand78QuantityDIF: 2 REF: 7-1 TOP: Consumer surplus 3.

NAT: Analytic

MSC: Applicative

LOC: Supply and demand

Answer each of the following questions about supply and producer surplus. a. What is producer surplus, and how is it measured?

b. What is the relationship between the cost to sellers and the supply curve?

c. Other things equal, what happens to producer surplus when the price of a good rises? Illustrate

your answer on a supply curve.

ANS:

a. Producer surplus measures the benefit to sellers of participating in a market. It is measured as the

amount a seller is paid minus the cost of production. For an individual sale, producer surplus is measured as the difference between the market price and the cost of production, as shown on the supply curve. For the market, total producer surplus is measured as the area above the supply curve and below the market price, between the origin and the quantity sold.

b. Because the supply curve shows the minimum amount sellers are willing to accept for a given

quantity, the supply curve represents the cost of the marginal seller.

c. When the price of a good rises, producer surplus increases for two reasons. First, those sellers

who were already selling the good have an increase in producer surplus because the price they receive is higher (area A). Second, new sellers will enter the market because the price of the good is now higher than their willingness to sell (area B); hence, there is additional producer surplus generated from their sales. The graph should show that as price rises from P1 to P2, producer surplus increases from area C to area A+B+C.

PriceSupplyP2AP1CGBDQ1Q2QuantityDIF: 2 REF: 7-2 TOP: Producer surplus NAT: Analytic

MSC: Interpretive

LOC: Supply and demand