FRAMINGHAM STATE COLLEGE
PRINCIPLES OF MICROECONOMICS
PROBLEM SET NUMBER 6
My Name is? ________________________________________
Text Chapter 7 Producer Surplus and Market Efficiency
2. Ernie owns a water pump. Because pumping large amounts of water is harder than pumping small
amounts, the cost of producing a bottle of water rises as he pumps more. Here is the cost he incurs
to produce each bottle of water:
Cost of first bottle
Cost of second bottle
Cost of third bottle
Cost of fourth bottle
a.
$1
$3
$5
$7
From this information, derive Ernie's supply schedule.
Ernie’s supply schedule for water is:
Price
More than
$7
$5 to $7
$3 to $5
$1 to $3
Less than
$1
b.
Quantity Supplied
4
3
2
1
0
Graph his supply curve for bottled water.
Ernie’s supply curve is shown in Figure 1.
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Problem Set Number 6
Figure 1
c.
If the price of a bottle of water is $4, how many bottles does Ernie produce and sell?
When the price of a bottle of water is $4, Ernie sells two bottles of water.
d.
How much producer surplus does Ernie get from these sales at $4 a bottle? Show Ernie's
producer surplus in your graph.
His producer surplus is shown as area A in the figure.
He receives $4 for his first bottle of water, but it costs only $1 to produce, so Ernie has
producer surplus of $3.
He also receives $4 for his second bottle of water, which costs $3 to produce, so he has
producer surplus of $1.
Thus Ernie’s total producer surplus is $3 + $1 = $4, which is the area of A in figure 1.
e.
If the price rises from $4 to $6, how does quantity supplied change? Tell me about the
change in quantity not the new quantity!
When the price of a bottle of water rises from $4 to $6, Ernie sells three bottles of water, an
increase of one.
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Problem Set Number 6
f.
How does Ernie's producer surplus change as the price rises from $4 to $6? Show these
changes in your graph.
His producer surplus consists of both areas A and B in the figure, an increase by the
amount of area B.
He gets producer surplus of $5 from the first bottle ($6 price minus $1 cost), $3 from the
second bottle ($6 price minus $3 cost), and $1 from the third bottle ($6 price minus $5
price), for a total producer surplus of $9.
Thus producer surplus rises by $5 (which is the size of area B) when the price of a bottle of
water rises from $4 to $6.
3.
Consider a market in which Bert from Problem 1 is the buyer and Ernie from Problem 2 is the
seller.
a.
Use Ernie's supply schedule and Bert's demand schedule to find the quantity supplied and
quantity demanded at prices of $2, $4, and $6. Which of these prices brings supply and
demand into equilibrium?
Price
b.
Quantity Supplied
Quantity Demanded
$2
1
3
$3
2
2
$6
3
1
Which of these prices brings supply and demand into equilibrium?
Only a price of $4 brings supply and demand into equilibrium, with an equilibrium
quantity of 2.
c.
What are consumer surplus, producer surplus, and total surplus in this equilibrium?
The consumer surplus is: At a price of $4, consumer surplus is $4
The producer surplus is: producer surplus is $4
Total surplus is $4 + $4 = $8.
d.
If Ernie produced and Bert consumed one fewer bottle of water, what would happen to
total surplus?
If Ernie produced one fewer bottle, his producer surplus would decline to $3, as shown in
problem 2. If Bert consumed one fewer bottle, his consumer surplus would decline to $3,
as shown in problem 1. So total surplus would decline to $3 + $3 = $6.
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Problem Set Number 6
e.
If Ernie produced and Bert consumed one additional bottle of water, what would happen to
total surplus?
If Ernie produced one additional bottle of water, his cost would be $5, but the price is only
$4, so his producer surplus would decline by $1. If Bert consumed one additional bottle of
water, his value would be $3, but the price is $4, so his consumer surplus would decline by
$1. So total surplus declines by $1 + $1 = $2.
Using the material covered in CHAPTER 8.
4.
The market for pizza is characterized by a downward-sloping demand curve and an upwardsloping supply curve.
Figure 2 illustrates the market for pizza. The equilibrium price is P1, the equilibrium
quantity is Q1, consumer surplus is area A+B+C, and producer surplus is area D+E+F.
Figure 2
a.
Draw the competitive market equilibrium. Label the price, quantity, consumer surplus, and
producer surplus.
b.
Is there any deadweight loss? Explain.
There is no deadweight loss, as all the potential gains from trade are realized; total surplus
is the entire area between the demand and supply curves⎯A+B+C+D+E+F.
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Problem Set Number 6
c.
Suppose that the government forces each pizzeria to pay a $1 tax on each pizza sold.
Illustrate the effect of this tax on the pizza market, being sure to label the consumer
surplus, producer surplus, government revenue, and deadweight loss. How does each area
compare to the pre-tax case?
With a $1 tax on each pizza sold, the price paid by buyers, PB, is now higher than the price
received by sellers, PS, where PB = PS + $1. The quantity declines to Q2, consumer surplus
is area A, producer surplus is area F, government revenue is area B+D, and deadweight
loss is area C+E. Consumer surplus declines by B+C, producer surplus declines by D+E,
government revenue increases by B+D, and deadweight loss increases by C+E.
d.
If the tax were removed, pizza eaters and sellers would be better off, but the government
would lose tax revenue. Suppose that consumers and producers voluntarily transferred
some of their gains the government. Could all parties (including the government) be better
off than they were with a tax? Explain using the labeled areas in your graph.
If the tax were removed and consumers and producers voluntarily transferred B+D to the
government to make up for the lost tax revenue, then everyone would be better off than
without the tax. The equilibrium quantity would be Q1, as in the case without the tax, and
the equilibrium price would be P1. Consumer surplus would be A+C, because consumers
get surplus of A+B+C, then voluntarily transfer B to the government. Producer surplus
would be E+F, since producers get surplus of D+E+F, then voluntarily transfer D to the
government. Both consumers and producers are better off than the case when the tax was
imposed. If consumers and producers gave a little bit more than B+D to the government,
then all three parties, including the government, would be better off. This illustrates the
inefficiency of taxation.
5.
Senator Daniel Patrick Moynihan once introduced a bill that would levy a 10,000 percent tax on
certain hollow-tipped bullets.
a.
Do you expect that this tax would raise much revenue? Why or why not?
This tax has such a high rate that it is not likely to raise much revenue. Because of the high
tax rate, the equilibrium quantity in the market is likely to be at or near zero.
b.
Even if the tax would raise no revenue, what might be Senator Moynihan's reason for
proposing it?
Senator Moynihan's goal was probably to ban the use of hollow-tipped bullets. In this
case, a tax is as effective as an outright ban.
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Problem Set Number 6