Questions and Problems

Check Your Understanding

1. Question

   Describe how consumer surplus and producer surplus are measured.

   Prob 4 1. Describe how consumer surplus and producer surplus are measured.

2. Question

   Using the graph below, show what happens to consumer surplus when a new technology reduces the cost of production.

   
   
   
   

   Prob 4 2. Using the graph below, show what happens to consumer surplus when a new technology reduces the cost of production.

3. Question

   Explain why deadweight loss can occur with a price below equilibrium even when some consumers benefit from it.

   Prob 4 3. Explain why deadweight loss can occur with a price below equilibrium even when some consumers benefit from it.

4. Question

   Provide three examples of activities that generate external benefits and three activities that generate external costs.

   Prob 4 4. Provide three examples of activities that generate external benefits and three activities that generate external costs.

5. Question

   Why does an effective price ceiling appear below the equilibrium rather than above it?

   Prob 4 5. Why does an effective price ceiling appear below the equilibrium rather than above it?

6. Question

   If a price floor is reduced toward equilibrium but not below it, does the surplus and deadweight loss in this market increase or decrease?

   Prob 4 6. If a price floor is reduced toward equilibrium but not below it, does the surplus and deadweight loss in this market increase or decrease?

Apply the Concepts

7. Question

   An increasing number of charities have turned to online auctions as a way to raise money by selling unique experiences donated by celebrities (such as a meet-and-greet with a celebrity before a concert or a walk-on role on a television show). Why would the use of auctions lead to a better outcome for the charity as opposed to just setting a fixed price? Explain using the concepts of consumer surplus and producer surplus.

   Prob 4 7. An increasing number of charities have turned to online auctions as a way to raise money by selling unique experiences donated by celebrities (such as a meet-and-greet with a celebrity before a concert or a walk-on role on a television show). Why would the use of auctions lead to a better outcome for the charity as opposed to just setting a fixed price? Explain using the concepts of consumer surplus and producer surplus.

8. Question

   Luigi’s is the only pizzeria in a small town in northern Alaska. It is constantly busy but there is never a wait for a table. One of Luigi’s friends suggests that he would earn much more money if he raises his menu prices by 25%, because no one is likely to open a new pizzeria in the near future. If Luigi follows his friend’s advice, what would happen to consumer and producer surplus, and efficiency, in this market?

   Prob 4 8. Luigi’s is the only pizzeria in a small town in northern Alaska. It is constantly busy but there is never a wait for a table. One of Luigi’s friends suggests that he would earn much more money if he raises his menu prices by 25%, because no one is likely to open a new pizzeria in the near future. If Luigi follows his friend’s advice, what would happen to consumer and producer surplus, and efficiency, in this market?

9. Question

   “If millions of people are desperate to buy and millions more desperate to sell, the trades will happen, whether we like it or not.” This quote from Martin Wolf1 refers to trades in illicit goods such as narcotics, knockoffs (counterfeit goods), slaves, organs, and other goods we generally refer to as “bads.” Wolf suggests that the only way to eliminate traffic in these illicit goods is to eliminate their profitability. Do you agree? Why or why not?

   Prob 4 9. “If millions of people are desperate to buy and millions more desperate to sell, the trades will happen, whether we like it or not.” This quote from Martin Wolf1 refers to trades in illicit goods such as narcotics, knockoffs (counterfeit goods), slaves, organs, and other goods we generally refer to as “bads.” Wolf suggests that the only way to eliminate traffic in these illicit goods is to eliminate their profitability. Do you agree? Why or why not?

10. Question

    Academic studies suggest that the amount people tip in restaurants is only slightly related to the quality of service, and that tips are poor measures of how happy people are with the service. Is this another example of market failure? What might account for this situation?

    Prob 4 10. Academic studies suggest that the amount people tip in restaurants is only slightly related to the quality of service, and that tips are poor measures of how happy people are with the service. Is this another example of market failure? What might account for this situation?

11. Question

    In the 1940s, rent controls were widely used in New York City, and to this day, tenants in rent-controlled apartments continue to pay low rents as long as they do not move. As a result, some of New York’s prime real estate is renting for a fraction of the true market value. Explain how the existence of rent controls affects the market prices for non-rent-controlled apartments. How are incentives by New York landlords affected in terms of maintaining rent-controlled and non-rent-controlled apartments?

    Prob 4 11. In the 1940s, rent controls were widely used in New York City, and to this day, tenants in rent-controlled apartments continue to pay low rents as long as they do not move. As a result, some of New York’s prime real estate is renting for a fraction of the true market value. Explain how the existence of rent controls affects the market prices for non-rent-controlled apartments. How are incentives by New York landlords affected in terms of maintaining rent-controlled and non-rent-controlled apartments?

12. Question

    The U.S. Department of Labor reports that of the roughly 155 million people employed, just over half are paid by the hour, but fewer than 5% earn the minimum wage or less; 95% of wage earners earn more. And of those earning the minimum wage or less, 25% are teenagers living at home. If so few people are affected by the minimum wage, why does it often seem to be such a contentious political issue?

    Prob 4 12. The U.S. Department of Labor reports that of the roughly 155 million people employed, just over half are paid by the hour, but fewer than 5% earn the minimum wage or less; 95% of wage earners earn more. And of those earning the minimum wage or less, 25% are teenagers living at home. If so few people are affected by the minimum wage, why does it often seem to be such a contentious political issue?

In the News

13. Question

    In 2009, the Hershey Company of Pennsylvania became the latest company to open a candy factory in Mexico (USA Today, February 13, 2009), joining other American candy companies including Brach’s Confections and Ferrara Pan Candy, which had opened plants there earlier. The reason for Hershey’s move was more than just lower wages; it was also because of lower sugar prices. Sugar prices in the United States have for many decades been supported in order to protect the American sugar industry and the thousands of farmers it employs. Using the tools of consumer and producer surplus, explain how the events described may have resulted from price supports for sugar.

    Prob 4 13. In 2009, the Hershey Company of Pennsylvania became the latest company to open a candy factory in Mexico (USA Today, February 13, 2009), joining other American candy companies including Brach’s Confections and Ferrara Pan Candy, which had opened plants there earlier. The reason for Hershey’s move was more than just lower wages; it was also because of lower sugar prices. Sugar prices in the United States have for many decades been supported in order to protect the American sugar industry and the thousands of farmers it employs. Using the tools of consumer and producer surplus, explain how the events described may have resulted from price supports for sugar.

14. Question

    Professor Donald Boudreaux wrote (Wall Street Journal, August 23, 2006, p. A11) that “there are heaps of bad arguments for raising the minimum wage. Perhaps the worst … is that a minimum wage increase is justified if a full-time worker earning the current minimum wage cannot afford to live in a city such as Chicago.” He then asked, “why settle for enabling workers to live only in the likes of Chicago? Why not raise the minimum wage so that everyone can afford to live in, say, Nantucket, Hyannis Port or Beverly Hills, within walking distance of Rodeo Drive?” Should the minimum wage be a “living wage,” so a full-time worker can live comfortably in a given locale? What would be the impact if minimum wages were structured this way?

    Prob 4 14. Professor Donald Boudreaux wrote (Wall Street Journal, August 23, 2006, p. A11) that “there are heaps of bad arguments for raising the minimum wage. Perhaps the worst … is that a minimum wage increase is justified if a full-time worker earning the current minimum wage cannot afford to live in a city such as Chicago.” He then asked, “why settle for enabling workers to live only in the likes of Chicago? Why not raise the minimum wage so that everyone can afford to live in, say, Nantucket, Hyannis Port or Beverly Hills, within walking distance of Rodeo Drive?” Should the minimum wage be a “living wage,” so a full-time worker can live comfortably in a given locale? What would be the impact if minimum wages were structured this way?

Solving Problems

15. Consider the market shown in the graph below.
    

    1. Question

       Compute the consumer surplus.

       Prob 4 15a. Compute the consumer surplus.

    2. Question

       Compute the producer surplus.
       Now assume that government puts a price floor on this product at $20 a unit.

       Prob 4 15b. Compute the producer surplus.
       Now assume that government puts a price floor on this product at $20 a unit.

    3. Question

       Compute the new consumer surplus.

       Prob 4 15c. Compute the new consumer surplus.

    4. Question

       Compute the new producer surplus.

       Prob 4 15d. Compute the new producer surplus.

    5. Question

       What group would tend to have their advocates or lobbyists support price floors?

       Prob 4 15e. What group would tend to have their advocates or lobbyists support price floors?
16. Suppose the U.S. government places a price ceiling on the sale of gasoline at $3 per gallon in the figure below.
    

    1. Question

       How much of a shortage or surplus of gasoline would result?

       Prob 4 16a. How much of a shortage or surplus of gasoline would result?

    2. Question

       Calculate the effects of this policy in terms of the changes in consumer surplus and producer surplus.

       Prob 4 16b. Calculate the effects of this policy in terms of the changes in consumer surplus and producer surplus.

    3. Question

       How much deadweight loss is created?

       Prob 4 16c. How much deadweight loss is created?

    4. Question

       What would happen if the price ceiling is raised to $6 per gallon?

       Prob 4 16d. What would happen if the price ceiling is raised to $6 per gallon?

17. Question

    According to By the Numbers, how much would you earn in one year if you worked 2,000 hours (50 weeks × 40 hours) at the federal minimum wage? How much more would you earn per year if you worked at the minimum wage rate in Washington state?

    Prob 4 17. According to By the Numbers, how much would you earn in one year if you worked 2,000 hours (50 weeks × 40 hours) at the federal minimum wage? How much more would you earn per year if you worked at the minimum wage rate in Washington state?

18. Question

    According to By the Numbers, which state received the highest average federal telephone support per capita in 2011? Approximately how much support did this state receive per resident? (Hint: search for the population of each state online to calculate the average support per person.)

    Prob 4 18. According to By the Numbers, which state received the highest average federal telephone support per capita in 2011? Approximately how much support did this state receive per resident? (Hint: search for the population of each state online to calculate the average support per person.)