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Gobbet 7 - Market Efficiency Solution

# Gobbet 7 - Market Efficiency Solution - Gobbet#7 Market...

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Gobbet #7: Market Efficiency: Solution (These problems are adapted from Callan and Thomas: Environmental Economics and Management , 2004) Consider the supply and demand schedules and the graph from Gobbet #4: PRICE (P) Quantity Demanded by Consumers (bottles/month) Quantity Supplied by Producers (bottles/month) \$0.50 1,100 100 1.00 1,050 300 1.50 1,000 500 2.00 950 700 2.50 900 900 3.00 850 1,100 3.50 800 1,300 4.00 750 1,500 4.50 700 1,700 5.00 650 1,900 Calculate the consumer surplus , producer surplus and net economic surplus in this market. SOLUTION: When answering such questions, it is always helpful to go back to basic definitions and understand the concepts, then translate these concepts to graphical areas, and then calculate the areas. 11.50 1,150 Demand= MB Quantity Price Supply = MC 0.25 2.50 900 1

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Definitions, concepts and relevant graphical areas: Consumer surplus is the net benefit that consumers receive from a product over and above what they actually pay for it. Technically it is the area below the demand curve (what consumers would be willing to pay for the unit) and above the price they actually have to pay (here, the market price of \$2.50 per unit). In the graph above, consumer surplus is represented by the area A . Producer surplus is defined as the difference between the price that producers receive for their goods and the costs of producing the goods. Technically it is the area under the price (here \$2.50) and above the marginal cost curve (the cost of producing each unit). In the graph above, producer surplus is represented by the area B . Net Economic Surplus (also called Total Economic Surplus or Total Net Benefit) can be defined as the total benefits of consumption minus the total costs to society of producing the good. This can also be defined as the sum of consumer surplus and producer surplus. In the graph above, total net economic surplus is represented by the area A + B . Calculating Relevant Areas: Recall that the formula for the area of a triangle is Area = ½ * base * height. Then the consumer surplus – the colored area A – can be found by calculating the area of the triangle with height equal to 11.50 – 2.50 = 9 and the base equal to 900. So the area representing consumer surplus is 11.50 1,150 Demand Quantity Price Supply 0.25 2.50 900 A B 2
½ * 900 * 9 = 4,050.

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