Seminar 3: Markets and Welfare Chapter 7: Consumers, Producers, and the Efficiency of Markets Chapter 8: Application: The Costs of Taxation Part 1: True/False Questions 1. For any given quantity, the price on a demand curve represents the marginal buyer's willingness to pay. 2. A buyer is willing to buy a product at a price greater than or equal to his willingness to pay but would refuse to buy a product at a price less than his willingness to pay. 3. Consumer surplus is the amount a buyer actually has to pay for a good minus the amount the buyer is willing to pay for it. 4. Consumer surplus can be measured as the area between the demand curve and the supply curve. 5. If Darby values a soccer ball at $50, and she pays $40 for it, her consumer surplus is $10. 6. If the government imposes a binding price floor in a market, then the consumer surplus in that market will increase. 7. All else equal, an increase in supply will cause an increase in consumer surplus. 8. Producer surplus is the cost of production minus the amount a seller is paid. 9. All else equal, a decrease in demand will cause an increase in producer surplus. 10. Connie can clean windows in large office buildings at a cost of $1 per window. The market price for window-cleaning services is $3 per window. If Connie cleans 100 windows, her producer surplus is $100. 11. The area below the demand curve and above the supply curve measures the producer surplus in a market. 12. Total surplus in a market is consumer surplus minus producer surplus. 13. When demand increases so that market price increases, producer surplus increases because (1) producer surplus received by existing sellers increases, and (2) new sellers enter the market. 14. Producing a soccer ball costs Jake $5. He sells it to Darby for $35. Darby values the soccer ball at $50. For this transaction, the total surplus in the market is $40. 15. Total surplus = Value to buyers - Costs to sellers. 16. Total surplus is always equal to the sum of consumer surplus and producer surplus. 17. When a tax is imposed on buyers, consumer surplus and producer surplus both decrease. 18. Taxes affect market participants by increasing the price paid by the buyer and received by the seller. 19. Taxes affect market participants by increasing the price paid by the buyer and decreasing the price received by the seller. 20. When a good is taxed, the tax revenue collected by the government equals the decrease in the welfare of buyers and sellers caused by the tax. 21. A tax places a wedge between the price buyers pay and the price sellers receive. 22. When a tax is imposed, the loss of consumer surplus and producer surplus as a result of the tax exceeds the tax revenue collected by the government. 23. Taxes cause deadweight losses because they prevent buyers and sellers from realizing some of the gains from trade. 24. The greater the elasticity of demand, the smaller the deadweight loss of a tax. 25. The elasticities of the supply and demand curves in the market for cigarettes affect how much a tax distorts that market. 26. If a tax did not induce buyers or sellers to change their behavior, it would not cause a deadweight loss. 27. Taxes on labor tend to increase the number of hours that people choose to work. 28. A tax on insulin is likely to cause a very large deadweight loss to society. 29. As the size of a tax increases, the government's tax revenue rises, then falls. 30. If the size of a tax triples, the deadweight loss increases by a factor of six. Part II: Short Answer Questions 1. 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? 2. Tammy loves donuts. The table shown reflects the value Tammy places on each donut she eats: Value of first donut Value of second donut Value of third donut Value of fourth donut Value of fifth donut Value of sixth donut $0.60 $0.50 $0.40 $0.30 $0.20 $0.10 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. 3. 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. 4. Answer the following questions based on the graph that represents J.R.'s demand for ribs per week of ribs at Judy's rib shack. a. b. c. d. e. f. g. h. i. 20 At the equilibrium price, how many ribs would J.R. be willing to purchase? How much is J.R. willing to pay for 20 ribs? What is the magnitude of J.R.'s consumer surplus at the equilibrium price? At the equilibrium price, how many ribs would Judy be willing to sell? How high must the price of ribs be for Judy to supply 20 ribs to the market? At the equilibrium price, what is the magnitude of total surplus in the market? If the price of ribs rose to $10, what would happen to J.R.'s consumer surplus? If the price of ribs fell to $5, what would happen to Judy's producer surplus? Explain why the graph that is shown verifies the fact that the market equilibrium (quantity) maximizes the sum of producer and consumer surplus. Price 18 16 14 Supply 12 10 8 6 5 4 Demand 2 10 20 30 40 50 60 70 80 Quantity 5. John has been in the habit of mowing Willa's lawn each week for $20. John's opportunity cost is $15, and Willa would be willing to pay $25 to have her lawn mowed. What is the maximum tax the government can impose on lawn mowing without discouraging John and Willa from continuing their mutually beneficial arrangement? 6. Use the following graph shown to fill in the table that follows. P4 Price Supply A P3 B C D G P2 P1 F Demand Q2 Q1 Quantity WITHOUT TAX WITH TAX CHANGE Consumer surplus Producer surplus Tax revenue Total surplus 7. Suppose that instead of a supply-demand diagram, you are given the following information: Qs = 100 + 3P Qd = 400 - 2P From this information compute equilibrium price and quantity. Now suppose that a tax is placed on buyers so that Qd = 400 - (2P + T). If T = 15, solve for the new equilibrium price and quantity. (Note: P is the price received by sellers and P + T is the price paid by buyers.) Compare these answers for equilibrium price and quantity with your first answers. What does this show you?