Homework 5 Answer Key Notes Correct answers highlighted in green explanation provided when deemed necessary Q1 A result of welfare economics is that the equilibrium price of a product is considered to be the best price because it a maximizes both the total revenue for firms and the quantity supplied of the product b maximizes the combined welfare of buyers and sellers c minimizes costs and maximizes output d minimizes the level of welfare payments Q2 Suppose Raymond and Victoria attend a charity benefit and participate in a silent auction Each has in mind a maximum amount that he or she will bid for an oil painting by a locally famous artist This maximum is called a deadweight loss b willingness to pay c consumer surplus d producer surplus Q3 Consider the following table Buyer Lori Audrey Zach Calvin Willingness To Pay 50 00 30 00 20 00 10 00 If the price of the product is 22 then who would be willing to purchase the product Explanation Only those willing to pay more than 22 will buy the product Q4 Again consider the table presented in the previous question If the price of the product is 18 then the total consumer surplus is Explanation If the price is 18 then Lory Audrey and Zach will purchase it The surplus earned by each of them is the difference between that person s WTP and the 18 price Lory s surplus is 50 18 32 Audrey s is 30 18 12 and Zach s is 20 18 2 Total surplus is then 32 12 2 46 a Lori b Lori and Audrey c Lori Audrey and Zach d Lori Audrey Zach and Calvin a 38 b 42 c 46 d 72 Q5 Consider the following table Buyer Michael Earvin Larry Charles Willingness to Pay 500 400 350 300 You have an extra ticket to the Midwest Regional Sweet 16 game in the men s NCAA basketball tournament The table shows the willingness to pay of the four potential buyers in the market for a ticket to the game You hold an auction to sell the ticket Who makes the winning bid and what does he offer to pay for the ticket a Michael 501 c Earvin 400 b Michael more than 400 but less than or equal to 500 d Earvin more than 350 but less than or equal to 400 Explanation The winner of the auction will be the person who is willing to pay the most which is Michael Michael most pay more than 400 otherwise Earvin would be willing and able to outbid him He cannot pay more than 500 as otherwise he would be paying more than what he is willing to pay Q6 Motor oil and gasoline are complements in consumption If the price of motor oil decreases consumer surplus in the gasoline market a decreases b is unchanged c increases d may increase decrease or remain unchanged Explanation A decrease in the price of motor will increase demand a shift to the right in the gasoline market as oil and gasoline are complements in consumption Let s visualize the shift and it effect on surplus graphically Note that the equilibrium price rises by less than the demand curve shifts up This means that each consumer s WTP has increased by more than the price has increased For the consumers who already were consuming the product before the change in demand this means an increase in surplus Moreover some consumers who were not consuming the product are now doing so those between Q1 and Q2 These individuals go from zero surplus to positive surplus Q7 Justin builds fences for a living Justin s out of pocket expenses for wood paint etc plus the value that he places on his own time amount to his a producer surplus b producer deficit c cost of building fences d profit Q8 Producer surplus measures the a net benefits to sellers of participating in a market b costs to sellers of participating in a market c price that buyers are willing to pay for sellers output of a good or service d benefit to sellers of producing a greater quantity of a good or service than buyers Q9 Consider the following table Cost 1 500 1 200 1 000 750 500 demand Seller Abby Bobby Carlos Dianne Evalina a 700 b 750 c 2 250 d 3 700 If the market price is 1 000 the producer surplus in the market is Explanation If the price of the good is 1 000 then only Evalina Dianne and Carlos will be willing to produce and sell it since they are the only ones whose cost of making the good is lower than its price Evalina s producer surplus is 1 000 500 500 Dianne s is 1 000 750 250 and Carlos s is 1 000 1 000 0 Total producer surplus is then 750 Q10 Suppose the demand for peaches decreases What will happen to producer surplus in the market for peaches a It increases b It decreases c It remains unchanged d It may increase decrease or remain unchanged Explanation The fall in demand reduces the equilibrium price and quantity draw the supply and demand diagram to see that this is indeed the case This inevitably results in a decrease in producer surplus Q11 ABC Company incurs a cost of 50 cents to produce a dozen eggs while XYZ Company incurs a cost of 70 cents to produce a dozen eggs Which of the following price increases would cause both companies to experience an increase in producer surplus a The price of a dozen eggs increases from 40 cents to 55 cents b The price of a dozen eggs increases from 55 cents to 70 cents c The price of a dozen eggs increases from 55 cents to 75 cents d All of these price increases would cause both companies to experience a loss in producer surplus Explanation For both companies to experience an increase in producer surplus the new price must be one at which both companies earn a producer surplus that is greater than zero This is only true in option c whereby the price increases to 75 cents Q 12 Suppose a tax of 1 per unit is imposed on a good The more elastic the supply of the good other things equal the a smaller is the response of quantity supplied to the tax b larger is the tax burden on sellers relative to the tax burden on buyers c larger is the deadweight loss of the tax d All of the above are correct Q13 The demand for potted plants is more elastic than the demand for wallpaper Suppose the government levies an equivalent tax on potted plants and wallpaper The deadweight loss would be larger in the market for a potted plants than in the market for wallpaper because the quantity of potted plants would fall by more than the quantity of wallpaper b potted plants than in the market for wallpaper because the quantity of wallpaper would fall by more than the quantity of potted plants c wallpaper than in the market …