ch07_End-of-chapter-question

ch07_End-of-chapter-question - Chapter 7 E ciency and...

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Unformatted text preview: Chapter 7 E ciency and exchange 8 June 2011 1. Suppose the weekly demand and supply curves for used DVDs in Lincoln, Nebraska, are as shown in the diagram. Calculate (a) The weekly consumer surplus. Answer: Equilibrium is achieved at a price where Q ( D ) = Q ( S ) . The equilibrium price is $10.50 per DVD and the corresponding equilibrium quantity is 6 units of DVD per week. Consumer surplus refers to the di erence between consumer's reservation price and the actual market price. Graphically, it is the area under the demand curve but above the actual market price. In this question, the weekly consumer surplus is (12- 10 . 5) × 6 2 = $4 . 5 . (b) The weekly producer surplus. Answer: Producer surplus refers to the di erence between producer's reservation price and the actual market price. Graphically, it is the area above the supply curve but under the actual market price. In this question, the weekly producer surplus is (10 . 5- 6) × 6 2 = $13 . 5 . (c) The maximum weekly amount that producers and consumers in Lincoln would be willing to pay to be able to buy and sell used DVDs in any given week. Answer: The maximum weekly amount that producers and consumers in Lincoln would be their willingness to pay in a week. In other words, it refers to the total gains from trading of used DVDs, which is the total economic surplus. Total economic surplus = consumer surplus + producer surplus = $4.5 + $13.5 = $18 per week. 2. Refer to problem 1. Suppose a coalition of students from Lincoln High School succeeds in persuading the local government to impose a price ceiling of $7.50 on used DVDs, on the grounds that local suppliers are taking advantage of teenagers by charging exorbitant prices. 1 (a) Calculate the weekly shortage that result from this policy. Answer: With price ceiling of $7.50, the quantity supplied from sellers is 2 DVDs per week. The quantity demanded at the current price of $7.50 is 18 DVDs per week. Thus, the price ceiling leads to an Excess Demand of 16 DVDs per week (18 DVDs/wk 2 DVDs/wk). Buyers cannot buy as much as they are willing to at the current price of $7.50. Therefore, the weekly shortage of used DVDs result from the price ceiling policy is 16 DVDs per week. What caused the shortage? The lower price (below the unintervented market equilibrium) encourages buyers of lower valuation to purchase the good, and discourage the sellers of higher production cost to quit the market. (b) Calculate the total economic surplus lost every week as a result of the price ceiling Answer: There are 2 approaches to nd the loss in economic surplus. Approach 1: With price ceiling of $7.50, sellers will sell only 2 DVDs/wk. Therefore, total economic surplus will be reduced by the shaded area....
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