Mankiw Ch 7

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Chapter 7 Efficiency
1. It’s a hot day and Bert is thirsty. Here is the value Bert places on a bottle of water.
Bottle Value
First
$7
Second
5
Third
3
Fourth
1
a. Graph Bert’s demand curve for water.
b. If P = $4/bottle, how many bottles does Bert buy?
c. What is his consumer surplus?
Consumer surplus ≡ Area below D curve and above P line.
d. Repeat b. and c. for P=$2/bottle.
2. Ernie bottles water. Here is his cost of producing water.
Bottle Cost
First
$1
Second
3
Third
5
Fourth
7
a. Graph Ernie’s supply curve.
b. If P=$4/bottle, how many bottles are produced?
c. What is Ernie’s producer surplus?
Producer surplus ≡ Area above S curve and below P line.
d. Repeat b. and c. for P=$6.
3. If Bert and Ernie are a market,
a. What is the equilibrium P & Q?
b. What are CS, PS and Total Surplus (TS=CS+PS)?
c. If Q fell by one, what would be TS?
d. If Q increased by one, what would be TS?
4. The point of the chapter
Under certain circumstances, the market equilibrium maximizes TS. In other words, the “invisible
hand” of the market place leads to an efficient allocation of resources.
Comments:
Assumes no “market failures” such as externalities (chapter 10) or monopoly (chapter 15).
Considers only total surplus – not how it is distributed (chapters 18-20)
Market probably performs even better in a dynamic context, i.e. promoting technological innovation
and rising living standards (chapter 25)
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