This Document Contains Chapters 3 to 4 Supply and Demand Chapter 3. A study conducted by Yahoo! revealed that chocolate is the most popular f lavor of ice cream in America. For each of the following, indicate the possible effects on demand, supply, or both as well as equilibrium price and quantity of chocolate ice cream. a. A severe drought in the Midwest causes dairy farmers to reduce the number of milk-producing cattle in their herds by a third. These dairy farmers supply cream that is used to manufacture chocolate ice cream. b. A new report by the American Medical Association reveals that chocolate does, in fact, have significant health benefits. c. The discovery of cheaper synthetic vanilla flavoring lowers the price of vanilla ice cream. d. New technology for mixing and freezing ice cream lowers manufacturers’ costs of producing chocolate ice cream. 1. a. By reducing their herds, dairy farmers reduce the supply of cream, a leftward shift of the supply curve for cream. As a result, the market price of cream rises, raising the cost of producing a unit of chocolate ice cream. This results in a leftward shift of the supply curve for chocolate ice cream as ice-cream producers reduce the quantity of chocolate ice cream supplied at any given price. Ultimately, this leads to a rise in the equilibrium price and a fall in the equilibrium quantity of chocolate ice cream. b. Consumers will now demand more chocolate ice cream at any given price, represented by a rightward shift of the demand curve. As a result, both equilibrium price and quantity rise. c. The price of a substitute (vanilla ice cream) has fallen, leading consumers to substitute it for chocolate ice cream. The demand for chocolate ice cream decreases, represented by a leftward shift of the demand curve. Both equilibrium price and quantity fall. d. Because the cost of producing ice cream falls, manufacturers are willing to supply more units of chocolate ice cream at any given price. This is represented by a rightward shift of the supply curve and results in a fall in the equilibrium price and a rise in the equilibrium quantity of chocolate ice cream. 2. In a supply and demand diagram, draw the shift of the demand curve for hamburgers in your hometown due to the following events. In each case, show the effect on equilibrium price and quantity. a. The price of tacos increases. b. All hamburger sellers raise the price of their french fries. c. Income falls in town. Assume that hamburgers are a normal good for most people. d. Income falls in town. Assume that hamburgers are an inferior good for most people. e. Hot dog stands cut the price of hot dogs. Chapter 3 2. a. A rise in the price of a substitute (tacos) causes the demand for hamburgers to increase. This represents a rightward shift of the demand curve from D1 to D2 and results in a rise in the equilibrium price and quantity as the equilibrium changes from E1 to E2. Price of hamburger S E2 P2 E1 P1 D2 D1 Q1 Q2 Quantity of hamburgers b. A rise in the price of a complement (french fries) causes the demand for hamburgers to decrease. This represents a leftward shift of the demand curve from D1 to D2 and results in a fall in the equilibrium price and quantity as the equilibrium changes from E1 to E2. Price of hamburger S E1 P1 E2 P2 D1 D2 Q2 Q1 Quantity of hamburgers c. A fall in income causes the demand for a normal good (hamburgers) to decrease. This represents a leftward shift of the demand curve from D1 to D2 and results in a fall in the equilibrium price and quantity as the equilibrium changes from E1 to E2. Price of hamburger S E1 P1 E2 P2 D2 Q2 Q1 D1 Quantity of hamburgers d. A fall in income causes the demand for an inferior good (hamburgers) to increase. This represents a rightward shift of the demand curve from D1 to D2 and results in a rise in the equilibrium price and quantity as the equilibrium changes from E1 to E2. Price of hamburger S E2 P2 E1 P1 D2 D1 Q1 Q2 Quantity of hamburgers e. A fall in the price of a substitute (hot dogs) causes demand for hamburgers to decrease. This is represented by a leftward shift of the demand curve from D1 to D2 and results in a fall in the equilibrium price and quantity as the equilibrium changes from E1 to E2. Price of hamburger S E1 P1 E2 P2 D2 Q2 D1 Q1 Quantity of hamburgers 3. The market for many goods changes in predictable ways according to the time of year, in response to events such as holidays, vacation times, seasonal changes in production, and so on. Using supply and demand, explain the change in price in each of the following cases. Note that supply and demand may shift simultaneously. a. Lobster prices usually fall during the summer peak lobster harvest season, despite the fact that people like to eat lobster during the summer more than at any other time of year. b. The price of a Christmas tree is lower after Christmas than before but fewer trees are sold. c. The price of a round-trip ticket to Paris on Air France falls by more than $200 after the end of school vacation in September. This happens despite the fact that generally worsening weather increases the cost of operating flights to Paris, and Air France therefore reduces the number of flights to Paris at any given price. 3. a. There is a rightward shift of the demand curve from D1 to D2 during the summer because consumers prefer to eat more lobster during the summer than at other times of the year. Other things equal, this leads to a rise in the price of lobster. Simultaneously, lobster fishermen produce more lobster during the summer peak harvest time, when it is cheaper to harvest lobster, representing a rightward shift of the supply curve of lobster from S1 to S2. Other things equal, this leads to a fall in the price of lobster. Given the simultaneous rightward shifts of both the demand and supply curves, the equilibrium changes from E1 to E2. The fall in price indicates that the rightward shift of the supply curve exceeds the rightward shift of the demand curve. Price of lobster S1 P1 S2 E1 E2 P2 D2 D1 Q1 Quantity of lobster Q2 b. There is a leftward shift of the demand curve for Christmas trees after Christmas from D1 to D2, as fewer consumers want Christmas trees at any given price. The supply curve does not shift; the reduction in the quantity of trees supplied is a movement along the supply curve. This leads to a fall in the equilibrium price and quantity, as the equilibrium changes from E1 to E2. Price of Christmas tree S P1 E1 P2 E2 D1 D2 Q2 Q1 Quantity of Christmas trees c. There is a leftward shift of the demand curve for tickets to Paris in September, after the end of school vacation, from D1 to D2. Other things equal, this leads to a fall in the price of tickets. At the same time, as the cost of operating flights increases, Air France decreases the number of flights, shifting the supply curve leftward from S1 to S2. Other things equal, this leads to a rise in price. Given the simultaneous leftward shifts of both the demand and supply curves, the equilibrium changes from E1 to E2. The fall in price indicates that the leftward shift of the demand curve exceeds the leftward shift of the supply curve. Price of ticket S2 P1 S1 E1 E2 P2 D2 Q2 D1 Q1 Quantity of tickets 4. Show in a diagram the effect on the demand curve, the supply curve, the equilibrium price, and the equilibrium quantity of each of the following events. a. The market for newspapers in your town Case 1: The salaries of journalists go up. Case 2: There is a big news event in your town, which is reported in the newspapers. b. The market for Seattle Seahawks cotton T-shirts Case 1: The Seahawks win the Super Bowl. Case 2: The price of cotton increases. c. The market for bagels Case 1: People realize how fattening bagels are. Case 2: People have less time to make themselves a cooked breakfast. d. The market for the Krugman and Wells economics textbook Case 1: Your professor makes it required reading for all of his or her students. Case 2: Printing costs for textbooks are lowered by the use of synthetic paper. 4. a. Case 1: Journalists are an input in the production of newspapers; an increase in their salaries will cause newspaper publishers to reduce the quantity supplied at any given price. This represents a leftward shift of the supply curve from S1 to S2 and results in a rise in the equilibrium price and a fall in the equilibrium quantity as the equilibrium changes from E1 to E2. Price of newspaper S2 P2 S1 E2 E1 P1 D Q2 Q1 Quantity of newspapers Case 2: Townspeople will wish to purchase more newspapers at any given price. This represents a rightward shift of the demand curve from D1 to D2 and leads to a rise in both the equilibrium price and quantity as the equilibrium changes from E1 to E2. Price of newspaper S P2 E2 P1 E1 D2 D1 Q1 Q2 Quantity of newspapers b. Case 1: Fans will demand more Seattle Seahawks memorabilia at any given price. This represents a rightward shift of the demand curve from D1 to D2 and leads to a rise in both the equilibrium price and quantity as the equilibrium changes from E1 to E2. Price of T-shirt S E2 P2 E1 P1 D2 D1 Q1 Q2 Quantity of T-shirts Case 2: Cotton is an input into T-shirts; an increase in its price will cause T-shirt manufacturers to reduce the quantity supplied at any given price, representing a leftward shift of the supply curve from S1 to S2. This leads to a rise in the equilibrium price and a fall in the equilibrium quantity as the equilibrium changes from E1 to E2. Price of T-shirt S2 S1 E2 P2 E1 P1 D Q2 Q1 Quantity of T-shirts c. Case 1: Consumers will demand fewer bagels at any given price. This represents a leftward shift of the demand curve from D1 to D2 and leads to a fall in both the equilibrium price and quantity as the equilibrium changes from E1 to E2. Price of bagel S P1 E1 E2 P2 D2 Q2 Q1 D1 Quantity of bagels Case 2: Consumers will demand more bagels (a substitute for cooked breakfasts) at any given price. This represents a rightward shift of the demand curve from D1 to D2 and leads to a rise in both the equilibrium price and quantity as the equilibrium changes from E1 to E2. Price of bagel S P2 E2 E1 P1 D2 D1 Q1 Q2 Quantity of bagels d. Case 1: A greater quantity of textbooks will be demanded at any given price, representing a rightward shift of the demand curve from D1 to D2. Equilibrium price and quantity will rise as the equilibrium changes from E1 to E2. Price of textbook S P2 E2 P1 E1 D2 D1 Q1 Q2 Quantity of textbooks Case 2: The textbook publisher will offer more textbooks for sale at any given price, representing a rightward shift of the supply curve from S1 to S2. Equilibrium price will fall and equilibrium quantity will rise as the equilibrium changes from E1 to E2. Price of textbook S1 P1 S2 E1 P2 E2 D Q1 Q2 Quantity of textbooks 5. Let’s assume that each person in the United States consumes an average of 37 gallons of soft drinks (nondiet) at an average price of $2 per gallon and that the U.S. population is 294 million. At a price of $1.50 per gallon, each individual consumer would demand 50 gallons of soft drinks. From this information about the individual demand schedule, calculate the market demand schedule for soft drinks for the prices of $1.50 and $2 per gallon. 5. The quantity demanded by an individual consumer at a price of $2 was 37 gallons, and there were 294 million consumers. Multiplying the quantity demanded at that price by each individual consumer gives us the market quantity demanded at that price: 294 million × 37 gallons = 10.9 billion gallons. Similarly, the market q uantity demanded at a price of $1.50 would be 294 million × 50 gallons = 14.7 billion gallons. 6. Suppose that the supply schedule of Maine lobsters is as follows: Price of lobster (per pound) Quantity of lobster supplied (pounds) $25 800 20 700 15 600 10 500 5 400 Suppose that Maine lobsters can be sold only in the United States. The U.S. demand schedule for Maine lobsters is as follows: Price of lobster (per pound) $25 Quantity of lobster demanded (pounds) 200 20 400 15 600 10 800 5 1,000 a. Draw the demand curve and the supply curve for Maine lobsters. What are the equilibrium price and quantity of lobsters? Now suppose that Maine lobsters can be sold in France. The French demand schedule for Maine lobsters is as follows: Price of lobster (per pound) Quantity of lobster demanded (pounds) $25 100 20 300 15 500 10 700 5 900 b. What is the demand schedule for Maine lobsters now that French consumers can also buy them? Draw a supply and demand diagram that illustrates the new equilibrium price and quantity of lobsters. What will happen to the price at which fishermen can sell lobster? What will happen to the price paid by U.S. consumers? What will happen to the quantity consumed by U.S. consumers? 6. a. The equilibrium price of lobster is $15 per pound and the equilibrium quantity is 600 pounds, point E in the accompanying diagram. Price of lobster (per pound) S $25 20 Equilibrium price E 15 10 5 D 0 200 300 400 500 600 700 800 900 1,000 Equilibrium quantity Quantity of lobster (pounds) b. The new demand schedule is obtained by adding together, at any given price, the quantity demanded by American consumers and the quantity demanded by French consumers, as shown in the accompanying table. Price of lobster (per pound) Quantity of lobster demanded (U.S. pounds plus French pounds) $25 300 20 700 15 1,100 10 1,500 5 1,900 The new equilibrium price of lobster is $20 per pound and the new equilibrium quantity is 700 pounds, point E in the accompanying diagram. The opportunity to sell to French consumers makes Maine fishermen better off: they sell more lobster and at a higher price than before. U.S. consumers, however, are made worse off: they must pay a higher price for lobster ($20 versus $15 per pound) and, as a result, consume less lobster (400 versus 600 pounds). Price of lobster (per pound) S $25 Equilibrium price E 20 15 10 5 0 D 300 700 Equilibrium quantity 1,100 1,500 1,900 Quantity of lobster (pounds) 7. Find the flaws in reasoning in the following statements, paying particular attention to the distinction between shifts of and movements along the supply and demand curves. Draw a diagram to illustrate what actually happens in each situation. a. “A technological innovation that lowers the cost of producing a good might seem at first to result in a reduction in the price of the good to consumers. But a fall in price will increase demand for the good, and higher demand will send the price up again. It is not certain, therefore, that an innovation will really reduce price in the end.” b. “A study shows that eating a clove of garlic a day can help prevent heart disease, causing many consumers to demand more garlic. This increase in demand results in a rise in the price of garlic. Consumers, seeing that the price of garlic has gone up, reduce their demand for garlic. This causes the demand for garlic to decrease and the price of garlic to fall. Therefore, the ultimate effect of the study on the price of garlic is uncertain.” 7. a. This statement confuses a shift of a curve with a movement along a curve. A technological innovation lowers the cost of producing the good, leading producers to offer more of the good at any given price. This is represented by a rightward shift of the supply curve from S1 to S2. As a result, the equilibrium price falls and the equilibrium quantity rises, as shown by the change from E1 to E2. The statement “but a fall in price will increase demand for the good, and higher demand will send the price up again” is wrong for the following reasons. A fall in price does increase the quantity demanded and leads to an increase in the equilibrium quantity as one moves down along the demand curve. But it does not lead to an increase in demand—a rightward shift of the demand curve—and therefore does not cause the price to go up again. Price S1 S2 E1 P1 E2 P2 D Q1 Q2 Quantity b. This statement also confuses a shift of a curve with a movement along a curve. The health report generates an increase in demand—a rightward shift of the demand curve from D1 to D2. This leads to a higher equilibrium price and quantity as we move up along the supply curve, and the equilibrium changes from E1 to E2. The following statements are wrong: “Consumers, seeing that the price of garlic has gone up, reduce their demand for garlic. This causes the demand for garlic to decrease and the price of garlic to fall.” They are wrong because they imply that the rise in the equilibrium price causes the demand for garlic to decrease—a leftward shift of the demand curve. But a rise in the equilibrium price via a movement along the supply curve does not cause the demand curve to shift leftward. Price S E2 P2 E1 P1 D1 Q1 Q2 D2 Quantity 8. The following table shows a demand schedule for a normal good. Price Quantity demanded $23 70 21 90 19 110 17 130 a. Do you think that the increase in quantity demanded (say, from 90 to 110 in the table) when price decreases (from $21 to $19) is due to a rise in consumers’ income? Explain clearly (and briefly) why or why not. b. Now suppose that the good is an inferior good. Would the demand schedule still be valid for an inferior good? c. Lastly, assume you do not know whether the good is normal or inferior. Devise an experiment that would allow you to determine which one it was. Explain. 8. a. The increase in quantity demanded from 90 to 110 when the price declines from $21 to $19 is not due to a rise in consumers’ income. Rather, it represents a movement along the demand curve as the price falls. In contrast, a rise in consumers’ income causes the demand curve to shift rightward for a normal good; as a result, the quantity demanded will increase at any given price. b. This demand schedule is valid for an inferior good because inferior goods obey the law of demand: a rise in the price leads to a fall in the quantity demanded, other things equal. c. You can determine whether a good is normal or inferior only by examining what happens to the demand after consumers’ income changes. A rise in income leads to an increase in demand for a normal good and a decrease in demand for an inferior good. A fall in income leads to a decrease in demand for a normal good and an increase in demand for an inferior good. So a suitable experiment would be to raise consumers’ income: if the quantity demanded at any given price rises, the good is normal; if the quantity demanded at any given price falls, the good is inferior. If you experiment by reducing consumers’ income, the results are reversed for the two types of goods. 9. In recent years, the number of car producers in China has increased rapidly. In fact, China now has more car brands than the United States. In addition, car sales have climbed every year and automakers have increased their output at even faster rates, causing fierce competition and a decline in prices. At the same time, C hinese consumers’ incomes have risen. Assume that cars are a normal good. Draw a diagram of the supply and demand curves for cars in China to explain what has happened in the Chinese car market. 9. As more automakers enter the Chinese market, the supply curve shifts to the right, from S1 to S2. And as Chinese consumers’ incomes rise, the demand curve for cars shifts to the right, from D1 to D2, because cars are a normal good. As a result, the equilibrium moves from its initial position at E1 to the new equilibrium at E2, and the quantity of cars bought and sold increases from Q1 to Q2. This accounts for the rapid increase in sales. Since the question mentions a decline in prices, the rightward shift of the supply curve must have been greater than the rightward shift of the demand curve. Price of car P1 S1 S2 E1 E2 P2 D1 Q1 Q2 D2 Quantity of cars 10. Aaron Hank is a star hitter for the Bay City baseball team. He is close to breaking the major league record for home runs hit during one season, and it is widely anticipated that in the next game he will break that record. As a result, tickets for the team’s next game have been a hot commodity. But today it is announced that, due to a knee injury, he will not in fact play in the team’s next game. Assume that season ticket-holders are able to resell their tickets if they wish. Use supply and demand diagrams to explain your answers to parts a and b. a. Show the case in which this announcement results in a lower equilibrium price and a lower equilibrium quantity than before the announcement. b. Show the case in which this announcement results in a lower equilibrium price and a higher equilibrium quantity than before the announcement. c. What accounts for whether case a or case b occurs? d. Suppose that a scalper had secretly learned before the announcement that Aaron Hank would not play in the next game. What actions do you think he would take? 10. a. Fewer fans want to attend the next game after the announcement is made. As a result, the demand curve will shift leftward from D1 to D2, as fewer tickets are demanded at any given price; other things equal, this results in a fall in both equilibrium price and quantity. In addition, the supply curve will shift rightward from S1 to S2, as more season ticket-holders are willing to sell tickets at any given price. Other things equal, this results in a fall in equilibrium price and a rise in equilibrium quantity. In this case, the leftward shift of the demand curve exceeds the rightward shift of the supply curve; as a result, equilibrium quantity falls, shown by the change of the equilibrium from E1 to E2. Price of ticket E1 P1 P2 S1 S2 E2 D1 D2 Q2 Q1 Quantity of tickets b. The supply and demand curves shift in the same manner as in part a, but in this case the rightward shift of the supply curve exceeds the leftward shift of the demand curve. Consequently, equilibrium quantity rises, shown by the change of the equilibrium from E1 to E2. Price of ticket P1 P2 S1 E1 S2 E2 D2 Q1 Q2 D1 Quantity of tickets c. Case a (equilibrium quantity falls) occurs because the decrease in demand exceeds the increase in supply. Case b (equilibrium quantity rises) occurs because the increase in supply exceeds the decrease in demand. d. A scalper who learns about the announcement secretly should take actions— such as lowering price somewhat—that ensure that he will sell all of his tickets before the announcement is made. He will do this because he knows a ticket will command a much lower price after the announcement. An expectation that the price will be lower in the future causes supply to increase today. 11. Fans of music often bemoan the high price of concert tickets. One rock superstar has argued that it isn’t worth hundreds, even thousands, of dollars to hear him and his band play. Let’s assume this star sold out arenas around the country at an average ticket price of $75. a. How would you evaluate the argument that ticket prices are too high? b. Suppose that due to this star’s protests, ticket prices were lowered to $50. In what sense is this price too low? Draw a diagram using supply and demand curves to support your argument. c. Suppose the superstar really wanted to bring down ticket prices. Since he and his band control the supply of their services, what do you recommend they do? Explain using a supply and demand diagram. d. Suppose the band’s next album was a total dud. Do you think they would still have to worry about ticket prices being too high? Why or why not? Draw a supply and demand diagram to support your argument. e. Suppose the group announced their next tour was going to be their last. What effect would this likely have on the demand for and price of tickets? Illustrate with a supply and demand diagram. 11. a. If markets are competitive, the ticket price is simply the equilibrium price: the price at which quantity supplied is equal to quantity demanded. No one is “made” to pay $75 to go to a concert: a potential concert-goer will pay $75 if going to the concert seems worth that amount and will choose to do something else if it isn’t. b. At $50 each, the quantity of tickets demanded exceeds the quantity of tickets supplied. There is a shortage of tickets at this price, shown by the difference between the quantity demanded at this price, QD, and the quantity supplied at this price, QS. Price of ticket S $75 E 50 Shortage 0 QS D QD Quantity of tickets c. The band can lower the average price of a ticket by increasing supply: give more concerts. This is shown as a rightward shift of the supply curve from S1 to S2, resulting in a lower equilibrium price and a higher equilibrium quantity, shown by the change of the equilibrium from E1 to E2. Price of ticket S1 P1 S2 E1 P2 E2 D Q1 Q2 Quantity of tickets d. If the band’s album is a total dud, the demand for concert tickets is likely to decrease. This represents a leftward shift of the demand curve from D1 to D2, resulting in a lower equilibrium price and quantity as the equilibrium changes from E1 to E2. This is likely to eliminate the worry that ticket prices are “too high.” Price of ticket S P1 E1 P2 E2 D2 Q2 Q1 D1 Quantity of tickets e. The announcement that this is the group’s last tour causes the demand for tickets to increase. This is represented by a rightward shift of the demand curve from D1 to D2, resulting in an increase in both the equilibrium price and quantity as the equilibrium changes from E1 to E2. Price of ticket S P2 E2 P1 E1 D1 Q1 Q2 D2 Quantity of tickets 12. After several years of decline, the market for handmade acoustic guitars is making a comeback. These guitars are usually made in small workshops employing relatively few highly skilled luthiers. Assess the impact on the equilibrium price and quantity of handmade acoustic guitars as a result of each of the following events. In your answers indicate which curve(s) shift(s) and in which direction. a. Environmentalists succeed in having the use of Brazilian rosewood banned in the United States, forcing luthiers to seek out alternative, more costly woods. b. A foreign producer reengineers the guitar-making process and floods the market with identical guitars. c. Music featuring handmade acoustic guitars makes a comeback as audiences tire of heavy metal and alternative rock music. d. The country goes into a deep recession and the income of the average A merican falls sharply. 12. a. The cost of producing handmade acoustic guitars rises as more costly woods are used to construct them. This reduces supply, as luthiers offer fewer guitars at any given price. This is represented by a leftward shift of the supply curve and results in a rise in the equilibrium price and a fall in the equilibrium quantity. b. This represents a rightward shift of the supply curve, resulting in a fall in the equilibrium price and a rise in the equilibrium quantity. c. As more people demand music played on acoustic guitars, the demand for these guitars by musicians increases as well. (Acoustic guitars are an input into the production of this music.) This represents a rightward shift of the demand curve, leading to a higher equilibrium price and quantity. d. If average American income falls sharply, then the demand for handmade acoustic guitars will decrease sharply as well because they are a normal good. This is represented by a leftward shift of the demand curve, leading to a lower equilibrium price and quantity. 13. Demand twisters: Sketch and explain the demand relationship in each of the following statements. a. I would never buy a Taylor Swift album! You couldn’t even give me one for nothing. b. I generally buy a bit more coffee as the price falls. But once the price falls to $2 per pound, I’ll buy out the entire stock of the supermarket. c. I spend more on orange juice even as the price rises. (Does this mean that I must be violating the law of demand?) d. Due to a tuition rise, most students at a college find themselves with less disposable income. Almost all of them eat more frequently at the school cafeteria and less often at restaurants, even though prices at the cafeteria have risen, too. (This one requires that you draw both the demand and the supply curves for school cafeteria meals.) 13. a. In this case, the quantity demanded is zero regardless of the price. So this person’s demand curve for Taylor Swift albums is a vertical line at the quantity of zero—that is, a vertical line that lies on top of the vertical axis. Price of Taylor Swift album D 0 Quantity of Taylor Swift albums b. The person here has the typical downward-sloping demand curve for coffee until it reaches the price of $2 per pound, at which point it becomes horizontal, showing that he or she would buy a very large quantity at that price. Price of coffee (per pound) $2 D 0 Quantity of coffee (pounds) c. This person does not necessarily violate the law of demand: the quantity of orange juice demanded may in fact fall as price goes up. The likely explanation is the following: spending is price times the quantity demanded. Although price goes up, the total amount of money this person spends on orange juice rises because he or she does not reduce the quantity demanded enough to offset the increased cost per unit. This person will have a steep demand curve as shown in the diagram: quantity demanded falls as price rises, but the fall in quantity demanded is proportionately less than the rise in price. Price of orange juice P2 Large price increase P1 D Q2 Q1 Quantity of orange juice Small quantity decrease d. Since students’ income has fallen, but the demand for cafeteria meals has increased, cafeteria meals must be an inferior good. The rightward shift of the demand curve, from D1 to D2, results in an increase in the equilibrium price and quantity of cafeteria meals, as the equilibrium changes from E1 to E2. Price of meal S E2 P2 P1 E1 D2 D1 Q1 Q2 Quantity of meals 14. Will Shakespeare is a struggling playwright in sixteenth-century London. As the price he receives for writing a play increases, he is willing to write more plays. For the following situations, use a diagram to illustrate how each event affects the equilibrium price and quantity in the market for Shakespeare’s plays. a. The playwright Christopher Marlowe, Shakespeare’s chief rival, is killed in a bar brawl. b. The bubonic plague, a deadly infectious disease, breaks out in London. c. To celebrate the defeat of the Spanish Armada, Queen Elizabeth declares several weeks of festivities, which involves commissioning new plays. 14. a. The death of Marlowe means that the supply of a substitute good (Marlowe’s plays) has decreased. As a result, the demand for Shakespeare’s plays will increase, inducing a rightward shift of the demand curve in the market for Shakespeare’s plays from D1 to D2. As a result, equilibrium price and quantity will rise as the equilibrium changes from E1 to E2. Price of Shakespeare play S P2 E2 P1 E1 D2 D1 Q1 Q2 Quantity of Shakespeare plays b. After the outbreak of the plague, fewer Londoners will wish to see Shakespeare’s plays to avoid contracting the illness, inducing a leftward shift of the demand curve from D1 to D2. Equilibrium price and quantity will fall as the equilibrium changes from E1 to E2. Price of Shakespeare play S P1 E1 P2 E2 D1 D2 Q2 Q1 Quantity of Shakespeare plays c. Queen Elizabeth’s commissions result in a greater quantity of Shakespeare’s plays demanded at any given price. This represents a rightward shift of the demand curve from D1 to D2, resulting in a higher equilibrium price and quantity as the equilibrium changes from E1 to E2. Price of Shakespeare play S P2 E2 P1 E1 D2 D1 Q1 Q2 Quantity of Shakespeare plays 15. This year, the small town of Middling experiences a sudden doubling of the birth rate. After three years, the birth rate returns to normal. Use a diagram to illustrate the effect of these events on the following. a. The market for an hour of babysitting services in Middling this year b. The market for an hour of babysitting services 14 years into the future, after the birth rate has returned to normal, by which time children born today are old enough to work as babysitters c. The market for an hour of babysitting services 30 years into the future, when children born today are likely to be having children of their own 15. a. There are more babies today, so the demand for an hour of babysitting services has increased. This produces a rightward shift of the demand curve for babysitting services from D1 to D2, resulting in a rise in the equilibrium price and quantity as the equilibrium changes from E1 to E2. Price of babysitting services S P2 E2 E1 P1 D2 D1 Q1 Q2 Quantity of babysitting services b. The children born today will cause an increase in the supply of babysitters available 14 years from now, when there will be a rightward shift of the supply curve for babysitting services from S1 to S2. This will result in a lower equilibrium price and a higher equilibrium quantity as the equilibrium changes from E1 to E2. Price of babysitting services S1 P1 S2 E1 E2 P2 D Q1 Q2 Quantity of babysitting services c. It is likely that there will be an increase in the number of babies born 30 years from now. Therefore, there will be an increase in the demand for babysitting services, shifting the demand curve rightward from D1 to D2. This will result in a higher equilibrium quantity and price as the equilibrium changes from E1 to E2. Price of babysitting services S E2 P2 P1 E1 D2 D1 Q1 Q2 Quantity of babysitting services 16. Use a diagram to illustrate how each of the following events affects the equilibrium price and quantity of pizza. a. The price of mozzarella cheese rises. b. The health hazards of hamburgers are widely publicized. c. The price of tomato sauce falls. d. The incomes of consumers rise, and pizza is an inferior good. e. Consumers expect the price of pizza to fall next week. 16. a. Mozzarella is an input in the production of pizza. Since the cost of an input has risen, pizza producers will reduce the quantity supplied at any given price, a leftward shift of the supply curve from S1 to S2. As a result, the equilibrium price of pizza will rise and the equilibrium quantity will fall as the equilibrium changes from E1 to E2. Price of pizza S2 P2 S1 E2 P1 E1 D Q2 Q1 Quantity of pizza b. Consumers will substitute pizza in place of hamburgers, resulting in an increased demand for pizza at any given price. This generates a rightward shift of the demand curve from D1 to D2, leading to a rise in the equilibrium price and quantity as the equilibrium changes from E1 to E2. Price of pizza S E2 P2 P1 E1 D2 D1 Q2 Quantity of pizza Q1 c. Tomato sauce is an input in the production of pizza. Since the cost of an input has fallen, pizza producers will increase the quantity supplied at any given price, a rightward shift of the supply curve from S1 to S2. As a result, the equilibrium price of pizza will fall and the equilibrium quantity will rise as the equilibrium changes from E1 to E2. Price of pizza S1 P1 S2 E1 P2 E2 D Q1 Q2 Quantity of pizza d. The demand for an inferior good decreases when the incomes of consumers rise. So a rise in consumer incomes produces a leftward shift of the demand curve from D1 to D2, resulting in a lower equilibrium price and quantity as the equilibrium changes from E1 to E2. Price of pizza S P1 E1 P2 E2 D1 D2 Q2 Q1 Quantity of pizza e. Consumers will delay their purchases of pizza today in anticipation of consuming more pizza next week. As a result, the demand curve shifts leftward from D1 to D2, resulting in a lower equilibrium price and quantity as the equilibrium changes from E1 to E2. Price of pizza S P1 E1 P2 E2 D1 D2 Q2 Q1 Quantity of pizza 17. Although he was a prolific artist, Pablo Picasso painted only 1,000 canvases during his “Blue Period.” Picasso is now dead, and all of his Blue Period works are currently on display in museums and private galleries throughout Europe and the United States. a. Draw a supply curve for Picasso Blue Period works. Why is this supply curve different from ones you have seen? b. Given the supply curve from part a, the price of a Picasso Blue Period work will be entirely dependent on what factor(s)? Draw a diagram showing how the equilibrium price of such a work is determined. c. Suppose rich art collectors decide that it is essential to acquire Picasso Blue Period art for their collections. Show the impact of this on the market for these paintings. 17. a. There are no more Picasso Blue Period works available. Hence the supply curve is a vertical line at the quantity 1,000. Price of painting 0 S 1,000 Quantity of paintings b. Since supply is fixed, the price of a Picasso Blue Period work is entirely determined by demand. Any change in demand is fully reflected in a change in price. S Price of painting Equilibrium price E D 0 1,000 Quantity of paintings c. This results in a rightward shift of the demand curve for these works from D1 to D2, and the equilibrium changes from E1 to E2. But since no more works are available, this increase in demand simply results in an increase in the equilibrium price. Price of painting S P2 E2 P1 E1 D2 D1 0 1,000 Quantity of paintings 18. Draw the appropriate curve in each of the following cases. Is it like or unlike the curves you have seen so far? Explain. a. The demand for cardiac bypass surgery, given that the government pays the full cost for any patient b. The demand for elective cosmetic plastic surgery, given that the patient pays the full cost c. The supply of reproductions of Rembrandt paintings 18. a. Since the government pays the full cost of cardiac bypass surgery, the price paid by the patient is always zero. Consequently, the demand for surgery is constant, regardless of the price actually paid by the government. The quantity demanded is constant at the quantity that would be demanded by patients if the government, not the patient, pays for surgery. That is, it is a vertical line at the quantity that patients would demand if the price of surgery to them were zero. Price of cardiac surgery D Quantity of cardiac surgeries b. In this case, the patient must pay the cost of the surgery, so the quantity demanded is affected by price, and the demand curve has its usual downwardsloping shape. Price of cosmetic surgery D Quantity of cosmetic surgeries c. The supply of Rembrandt reproductions is not fixed because they can be created by existing artists. So the supply curve of these reproductions has the familiar upward-sloping shape. Price of reproduction Rembrandt painting S Quantity of reproduction Rembrandt paintings 19. In each of the following, what is the mistake that underlies the statement? Explain the mistake in terms of supply and demand and the factors that influence them. a. Consumers are illogical because they are buying more Starbucks beverages in 2016 despite the fact that Starbucks has raised prices from 10 to 30 cents per drink. b. Consumers are illogical because they buy less at Cost-U-Less Warehouse Superstore when their incomes go up. c. Consumers are illogical for buying an iPhone 7 when an iPhone 5 costs less. 19. a. This statement ignores the possibility that consumers are buying more Starbucks beverages despite higher prices because (i) their incomes went up; or (ii) the price of a substitute good has gone up. In either of these cases the demand for Starbucks beverages rises (the demand curve shifts rightward), as consumers are willing to buy more Starbucks beverages at every price. b. This statement ignores the fact that consumers are likely to consider items at Cost-U-Less Warehouse Superstore as inferior goods, so will purchase fewer items there when their incomes rise. c. This statement is based on the erroneous assumption that an iPhone 5 is a perfect substitute for an iPhone 7. Consumers are willing to spend more for an iPhone 7 because it has many more features than an iPhone 5 (it’s faster, has a better camera and battery, etc.). Some consumers, however, may prefer not to have these features, and they can choose to buy the less expensive iPhone 5 instead. 20. In 2016 the price of oil fell to a 12-year low. For drivers, the cost of driving fell significantly as gasoline prices plunged. For the airline industry, the cost of operation also fell significantly because jet fuel is a major expense. a. Draw a supply and demand diagram that illustrates the effect of a fall in the price of jet fuel on the supply of air travel. b. Draw a supply and demand diagram that illustrates the effect of a fall in the price of oil on the demand for air travel. (Hint: think about this in terms of the substitutes for air travel, like driving.) c. Put the diagrams from parts a and b together. What happens to the equilibrium price and quantity of air travel? Despite the fall in the cost of driving, many more Americans chose to fly to their destinations during 2014 to 2016, as incomes rose and people splurged on vacations that had been postponed during the Great Recession. d. Using your results from part c, modify your diagram to illustrate an outcome in which the equilibrium price of air travel rises as people take more vacations by air. 20. a. A fall in the price of jet fuel leads to a rise in supply of air travel. Price of air travel S S (after fall in P1 fuel price) E1 E2 P2 D Q1 Q2 Quantity of air travel b. A fall in the price of oil means that the price of a substitute good, travel by car, has fallen. As a result, the demand for air travel falls. Price of air travel S E1 P1 E2 P2 (after fall in fuel price) D Q2 Q1 D Quantity of air travel c. When supply rises and demand falls simultaneously, price falls but the change in quantity is ambiguous. That is, the quantity could fall, or it could rise, or it could stay the same. Price of air travel S S (after fall in P1 P2 fuel price) E1 E2 (after fall D in fuel price) Q2 Q1 D Quantity of air travel d. A rise in income leads consumers to demand more air travel at every price, leading to an outward shift of the demand curve. If the increase in demand is high enough, as shown in the following diagram, the equilibrium price rises despite the fact that supply has also increased. Price of air travel S E2 P2 P1 S (after fall in fuel price) E1 D (after increase in income) D Q1 Q2 Quantity of air travel WORK IT OUT Interactive step-by-step help with solving this problem can be found online. 21. The accompanying table gives the annual U.S. demand and supply schedules for pickup trucks. Price of truck Quantity of trucks demanded (millions) Quantity of trucks supplied (millions) $20,000 20 14 25,000 18 15 30,000 16 16 35,000 14 17 40,000 12 18 a. Plot the demand and supply curves using these schedules. Indicate the equilibrium price and quantity on your diagram. b. Suppose the tires used on pickup trucks are found to be defective. What would you expect to happen in the market for pickup trucks? Show this on your diagram. c. Suppose that the U.S. Department of Transportation imposes costly regulations on manufacturers that cause them to reduce supply by one-third at any given price. Calculate and plot the new supply schedule and indicate the new equilibrium price and quantity on your diagram. 21. a. The supply curve is S1 and the demand curve is D1. The equilibrium in the market for pickup trucks is indicated by point E1, with an equilibrium price of $30,000 and an equilibrium quantity of 16 million trucks bought and sold. Price of truck S1 $40,000 35,000 Equilibrium price E1 30,000 25,000 20,000 0 D1 12 13 14 15 16 17 Equilibrium quantity 18 19 20 Quantity of trucks (millions) b. The announcement of a defect is likely to decrease the demand for pickup trucks. This is represented by a leftward shift of the demand curve, as shown by the shift from D1 to D2, and causes the equilibrium price and quantity to fall as the equilibrium changes from E1 to E2. Price of truck S1 E1 P1 E2 P2 D1 D2 Q2 Q1 Quantity of trucks (millions) c. The new supply schedule is as follows. Price of truck Quantity of trucks supplied (millions) $20,000 9.3 25,000 10.0 30,000 10.7 35,000 11.3 40,000 12.0 This one-third decrease in the quantity supplied at any given price is shown as a leftward shift of the supply curve from S1 to S2. It results in a new, higher equilibrium price, $40,000 per truck, and a lower equilibrium quantity, 12 million trucks, as shown by the change of the equilibrium from E1 to E3. Price of truck S2 P3 $40,000 E3 35,000 P1 S1 E1 30,000 25,000 20,000 0 D1 9 10 11 12 13 14 15 16 17 18 19 20 Q3 Q1 Quantity of trucks (millions) Consumer and Producer Surplus 1. Determine the amount of consumer surplus generated in each of the following situations. a. Leon goes to the clothing store to buy a new T-shirt, for which he is willing to pay up to $10. He picks out one he likes with a price tag of exactly $10. When he is paying for it, he learns that the T-shirt has been discounted by 50%. b. Alberto goes to the music store hoping to find a used copy of Nirvana’s Nevermind for up to $30. The store has one copy of the record selling for $30, which he purchases. c. After soccer practice, Stacey is willing to pay $2 for a bottle of mineral water. The 7-Eleven sells mineral water for $2.25 per bottle, so she declines to purchase it. 1. a. Leon’s consumer surplus is $5. This is the difference between how much he is willing to pay ($10) and how much he does pay ($5). b. Since Alberto’s willingness to pay is $30 and the price of the record is $30, he gets zero consumer surplus. c. No trade takes place because Stacey’s willingness to pay is less than the price. So no consumer surplus is created. 2. Determine the amount of producer surplus generated in each of the following situations. a. Gordon lists his old Lionel electric trains on eBay. He sets a minimum acceptable price, known as his reserve price, of $75. After five days of bidding, the final high bid is exactly $75. He accepts the bid. b. So-Hee advertises her car for sale in the used-car section of the student newspaper for $2,000, but she is willing to sell the car for any price higher than $1,500. The best offer she gets is $1,200, which she declines. c. Sanjay likes his job so much that he would be willing to do it for free. However, his annual salary is $80,000. 2. a. Gordon will receive no producer surplus since the price received for the trains is equal to his cost. b. No trade takes place because So-Hee’s cost is $1,500, which is higher than the price of $1,200 she is offered. So no producer surplus is created. c. Sanjay’s cost is zero. The price he is paid for his time is $80,000, so his producer surplus is $80,000. 3. There are six potential consumers of computer games, each willing to buy only one game. Consumer 1 is willing to pay $40 for a computer game, consumer 2 is willing to pay $35, consumer 3 is willing to pay $30, consumer 4 is willing to pay $25, consumer 5 is willing to pay $20, and consumer 6 is willing to pay $15. a. Suppose the market price is $29. What is the total consumer surplus? b. The market price decreases to $19. What is the total consumer surplus now? c. When the price fell from $29 to $19, how much did each consumer’s individual consumer surplus change? How does total consumer surplus change? Chapter 4 3. a. Consumer 1 buys a game since her willingness to pay is greater than the price. She gains $40 − $29 = $11. Consumer 2 buys a game since his willingness to pay is greater than the price. He gains $35 − $29 = $6. Consumer 3 buys a game since her willingness to pay is greater than the price. She gains $30 − $29 = $1. The total consumer surplus is $11 + $6 + $1 = $18. b. Consumer 1 buys a game since her willingness to pay is greater than the price. She gains $40 − $19 = $21. Consumer 2 buys a game since his willingness to pay is greater than the price. He gains $35 − $19 = $16. Consumer 3 buys a game since her willingness to pay is greater than the price. She gains $30 − $19 = $11. Consumer 4 buys a game since his willingness to pay is greater than the price. He gains $25 − $19 = $6. Consumer 5 buys a game since her willingness to pay is greater than the price. She gains $20 − $19 = $1. The total consumer surplus is $21 + $16 + $11 + $6 + $1 = $55. c. Total consumer surplus increases by $55 − $18 = $37 as a result of the price decrease. For consumers 1, 2, and 3 (the consumers who would also have bought games at the higher price), individual consumer surplus increases by $10 each, the amount of the price reduction. This accounts for $30 of the increase in consumer surplus. But consumers 4 and 5 now also get consumer surplus, since the lower price leads them to buy computer games also. Consumer 4 gets $6 of consumer surplus, and consumer 5 gets $1, accounting for the remaining $7 of additional consumer surplus. 4. a. In an auction, potential buyers compete for a good by submitting bids. Adam Galinsky, a social psychologist at Northwestern University, compared eBay auctions in which the same good was sold. He found that, on average, the higher the number of bidders, the higher the sales price. For example, in two auctions of identical iPads, the one with the higher number of bidders brought a higher selling price. According to Galinsky, this explains why smart sellers on eBay set absurdly low opening prices (the lowest price that the seller will accept), such as 1 cent for a new iPad. Use the concepts of consumer and producer surplus to explain Galinsky’s reasoning. b. You are considering selling your first car. If the car is in good condition, it is worth a lot; if it is in poor condition, it is useful only as scrap. Assume that your car is in excellent condition but that it costs a potential buyer $40 for a CARFAX report to determine the car’s condition. Use what you learned in part a to explain whether or not you should pay for the CARFAX report and share the results with all interested buyers. 4. a. The higher the sales price, the greater the producer surplus received by a seller. So Galinsky’s observation that a larger number of bidders results in a higher sales price means that a seller will want to take actions that increase the number of bidders for her good. The way to do this is to set a lower opening price. When the opening price is low, the seller is allowing more of the total surplus to be available to the winning bidder at the beginning of the auction. A potential buyer is more likely to bid if the opening price is low because he believes he can get a large share of the total surplus (that is, a large amount of consumer surplus) if he wins. If no one else bids, the bidder will indeed get that large amount of consumer surplus. But a low opening price also attracts other bidders, which, on average, increases the selling price and delivers more of the total surplus to the seller. b. If each potential buyer for your car has to pay $40 for the CARFAX report or take the chance of paying for a car that is in poor condition, then very few people will want to buy your car. And as shown in part a, with fewer buyers it is likely that you will receive less for your car than if you had a larger number of buyers. Many more people, though, will want to buy your car if they are able to find out, for free, that it is in excellent condition. So it would be smart of you to increase the number of potential buyers by paying for the inspection report yourself and sharing it freely. 5. Assume that due to a decrease in demand, the average domestic airline fare decreased from $371.72 in the third quarter of 2015 to $362.56 in the fourth quarter of the same year, a decrease of $9.16. The number of passenger tickets sold in the third quarter was 183.9 million and 175.9 million in the fourth quarter. Over the same period, the airlines’ costs remained roughly the same: the price of jet fuel averaged around $2 per gallon in both quarters and airline pilots’ salaries remained roughly the same, averaging $117,290 per year in 2015). Can you determine precisely by how much producer surplus has decreased as a result of the $9.16 decrease in the average fare? If you cannot be precise, can you determine whether it will be less than, or more than, a specific amount? 5. Without knowing the exact supply curve, you cannot be specific about the decrease in producer surplus. If the quantity of tickets supplied had not changed, producer surplus would have decreased by $9.16 × 183.9 million = $1.864 billion. But since supply curves normally slope upward and because the price has decreased, producer surplus will have decreased by less than $1.864 billion. 6. The accompanying table shows the supply and demand schedules for used copies of the fourth edition of this textbook. The supply schedule is derived from offers at Amazon.com. The demand schedule is hypothetical. Price of book Quantity of books demanded Quantity of books supplied $55 50 0 60 35 1 65 25 3 70 17 3 75 14 6 80 12 9 85 10 10 90 8 18 95 6 22 100 4 31 105 2 37 110 0 42 a. Calculate consumer and producer surplus at the equilibrium in this market. b. Now the fifth edition of this textbook becomes available. As a result, the willingness to pay of each potential buyer for a second-hand copy of the fourth edition falls by $20. In a table, show the new demand schedule and again calculate consumer and producer surplus at the new equilibrium. 6. a. The equilibrium price is $85, and 10 copies are bought and sold. Starting with the buyers with the highest willingness to pay, the first two buyers’ willingness to pay is $105, and so they each receive consumer surplus of $105 − $85 = $20. The next two buyers’ willingness to pay is $100, and so they each receive consumer surplus of $100 − $85 = $15. The next two buyers’ willingness to pay is $95, and so they each receive consumer surplus of $95 − $85 = $10. The next two buyers’ willingness to pay is $90, and so they each receive consumer surplus of $90 − $85 = $5. The next two buyers’ willingness to pay is $85, and so they each receive consumer surplus of $85 − $85 = $0. All remaining potential buyers receive no consumer surplus since their willingness to pay is below the market price. Total consumer surplus is therefore 2 × $20 + 2 × $15 + 2 × $10 + 2 × $5 = $100. Starting with the sellers with the lowest cost, the first seller’s cost is $60, and so she receives producer surplus of $85 − $60 = $25. The next two sellers’ cost is $65, and so they each receive producer surplus of $85 − $65 = $20. The next three sellers’ cost is $75, and so they each receive producer surplus of $85 − $75 = $10. The next three sellers’ cost is $80, and so they each receive producer surplus of $85 − $80 = $5. The next seller’s cost is $85, and so she receives producer surplus of $85 − $85 = $0. All remaining potential sellers receive no producer surplus since their cost is above the market price. Total producer surplus is therefore 1 × $25 + 2 × $20 + 3 × $10 + 3 × $5 = $110. b. The new demand schedule is shown in the accompanying table. Price of book Quantity of books demanded Quantity of books supplied $55 14 0 60 12 1 65 10 3 70 8 3 75 6 6 80 4 9 85 2 10 The equilibrium price is $75, and 6 copies are bought and sold. Starting with the buyers with the highest willingness to pay, the first two buyers’ willingness to pay is $85, and so they each receive consumer surplus of $85 − $75 = $10. The next two buyers’ willingness to pay is $80, and so they each receive consumer surplus of $80 − $75 = $5. The next two buyers’ willingness to pay is $75, and so they each receive consumer surplus of $75 − $75 = $0. All remaining potential buyers receive no consumer surplus since their willingness to pay is below the market price. So total consumer surplus is 2 × $10 + 2 × $5 = $30. Starting with the sellers with the lowest cost, the first seller’s cost is $60, and so she receives producer surplus of $75 − $60 = $15. The next two sellers’ cost is $65, and so they each receive producer surplus of $75 − $65 = $10. The next three sellers’ cost is $75, and so they each receive producer surplus of $75 − $75 = $0. All remaining potential sellers receive no producer surplus since their cost is above the market price. Total producer surplus is therefore 1 × $15 + 2 × $10 = $35. 7. On Thursday nights, a local restaurant has a pasta special. Ari likes the restaurant’s pasta, and his willingness to pay for each serving is shown in the accompanying table. Quantity of pasta (servings) Willingness to pay for pasta (per serving) 1 $10 2 8 3 6 4 4 5 2 6 0 a. If the price of a serving of pasta is $4, how many servings will Ari buy? How much consumer surplus does he receive? b. The following week, Ari is back at the restaurant again, but now the price of a serving of pasta is $6. By how much does his consumer surplus decrease compared to the previous week? c. One week later, he goes to the restaurant again. He discovers that the restaurant is offering an “all-you-can-eat” special for $25. How much pasta will Ari eat, and how much consumer surplus does he receive now? d. Suppose you own the restaurant and Ari is a typical customer. What is the highest price you can charge for the “all-you-can-eat” special and still attract customers? 7. a. Ari will buy four servings of pasta. His consumer surplus is equal to $12, that is: ($10 − $4) + ($8 − $4) + ($6 − $4) + ($4 − $4) = $12. b. Ari will buy three servings of pasta. His consumer surplus is ($10 − $6) + ($8 − $6) + ($6 − $6) = $6, so his consumer surplus falls by $6, from $12 to $6. c. If there is an “all-you-can-eat” special, the price Ari pays per serving is zero. Therefore, he will eat six servings of pasta. The total amount he is willing to pay for those six servings is $30, the sum of the amounts he is willing to pay for each individual serving. Since he actually pays $25, his consumer surplus is $5. d. When there is an “all-you-can-eat” special, Ari will consume six servings, which, if free, would give him consumer surplus of $30. Therefore, the most he is willing to pay for an “all-you-can-eat” special is $30. If Ari is a typical customer, this is the highest price you can charge for the special. 8. You are the manager of Fun World, a small amusement park. The accompanying diagram shows the demand curve of a typical customer at Fun World. Price of ride $10 5 D 0 10 20 Quantity of rides (per day) a. Suppose that the price of each ride is $5. At that price, how much consumer surplus does an individual consumer get? (Recall that the area of a right triangle is ½ × the height of the triangle × the base of the triangle.) b. Suppose that Fun World considers charging an admission fee, even though it maintains the price of each ride at $5. What is the maximum admission fee it could charge? (Assume that all potential customers have enough money to pay the fee.) c. Suppose that Fun World lowered the price of each ride to zero. How much consumer surplus does an individual consumer get? What is the maximum admission fee Fun World could charge? 8. a. From the demand curve, you can see that with a price per ride of $5, the customer takes 10 rides. At this point her consumer surplus is ½ × ($10 − $5) × 10 = $25. b. Since a consumer obtains consumer surplus of $25 from going to Fun World when each ride costs $5, that is the most that she would be willing to pay to go there. And it is therefore the maximum admission fee that Fun World could charge. (Charging consumers both an entrance fee and a price for each unit of a good bought is called a two-part tariff.) c. If Fun World charged nothing for each ride, a typical consumer would consume 20 rides, and this would give her a consumer surplus of ½ × $10 × 20 = $100. This is the maximum admission fee that Fun World can charge with a price per ride of zero. 9. The accompanying diagram illustrates a taxi driver’s individual supply curve (assume that each taxi ride is the same distance). Price of taxi ride S $8 4 0 40 80 Quantity of taxi rides a. Suppose the city sets the price of taxi rides at $4 per ride, and at $4 the taxi driver is able to sell as many taxi rides as he desires. What is this taxi driver’s producer surplus? (Recall that the area of a right triangle is ½ × the height of the triangle × the base of the triangle.) b. Suppose that the city keeps the price of a taxi ride set at $4, but it decides to charge taxi drivers a “licensing fee.” What is the maximum licensing fee the city could extract from this taxi driver? c. Suppose that the city allowed the price of taxi rides to increase to $8 per ride. Again assume that, at this price, the taxi driver sells as many rides as he is willing to offer. How much producer surplus does an individual taxi driver now get? What is the maximum licensing fee the city could charge this taxi driver? 9. a. At a price of $4, the taxi driver supplies 40 rides. His producer surplus is therefore ½ × $4 × 40 = $80. b. Since the taxi driver’s producer surplus is $80, this is the most he is willing to pay to supply 40 rides at $4. So it is the most the city can charge him as a licensing fee. c. At a price of $8, the taxi driver supplies 80 rides, making his producer surplus ½ × $8 × 80 = $320. So $320 is the most the city can charge as a licensing fee when the price per ride is $8. 10. Streaming music services have changed the way we listen to music. Spotify, Pandora, Tidal, and Google Play are some of the more popular services. These companies offer free access to music. For a small monthly fee users can purchase premium access and listen to millions of songs on demand and ad free. But not all artists are fans of free streaming music. In 2016, Taylor Swift’s move to prevent Spotify from playing her new release, 1989, for free, made national headlines. When Spotify refused to restrict access to only paying customers, Swift would not allow the company to play her music for free. She is not alone. Adele, Dr. Dre, Garth Brooks, and Coldplay have all had run-ins with free streaming services. a. If music lovers obtain music and video content via free music streaming services, instead of buying it directly or paying for premium access, what would the record companies’ producer surplus be from music sales? What are the implications for record companies’ incentive to produce music content in the future? b. If Taylor Swift and other artists were not allowed to pull their music from the free streaming services, what would happen to mutually beneficial transactions (the producing and buying of music) in the future? 10. a. If all music lovers obtain their music and video content for free, the producer surplus for record companies would be zero. They would have no incentive to record and produce more music. But, by giving consumers the option to directly purchase music or to access it via premium streaming services, record companies increase their own producer surplus and the producer surplus of their recording artists. Both now have an incentive to continue producing music. b. In the United States, artists like Swift have property rights: as an owner of a valuable resource (Swift’s songs are worth millions of dollars), she has the right to dispose of her property as she wishes. Preventing Swift from removing her songs from free streaming services would restrict her property rights, resulting in lower producer surplus. In addition, many otherwise mutually beneficial transactions would not occur because Swift would have no incentive to produce more music. 11. On December 17th, 2015, tickets for Adele’s highly anticipated U.S. concert tour went on sale at Ticketmaster on a first come, first served basis. Throughout the day, a record 10 million people tried to purchase the 750,000 tickets available. In an attempt to prevent ticket scalping, Adele and Ticketmaster limited buyers to four tickets per concert and required that premium seat holders present the credit card used to purchase tickets to get into the concert. Despite these attempts to restrict resale, tickets on secondary sites like StubHub, were selling for ten times their face value. a. Draw a supply and demand diagram that depicts the market for Adele concert tickets. Assume all tickets cost $150. Label the equilibrium price, quantity, and resulting shortage. b. In your diagram, highlight or label the areas that correspond to consumer surplus, producer surplus, and total surplus. c. Explain how reselling tickets on secondary sites can increase consumer surplus. 11. a. Price of tickets S X E PE Y A $150 Z 0 B Shortage 750,000 D 10,000,000 Quantity of tickets From the diagram, you can see that the demand curve for Adele tickets takes the traditional downward slope, but the supply curve is vertical at a quantity of 750,000 tickets. The figure also shows that the equilibrium price, PE, is much greater than the $150 charged by Ticketmaster. Point B shows that the quantity demanded for tickets is 10,000,000 at a price of $150. b. In the diagram from part a, consumer surplus equals the areas of X and Y, producer surplus is area Z, and total surplus equals the areas X + Y + Z. c. Tickets for the Adele concerts were distributed online on a first come, first served basis. Most of her 10 million fans tried to buy tickets immediately. Given that tickets were selling on secondary sites for ten times their face value, many fans were willing to pay more than $150 per ticket. In the diagram from part a, we assume consumer surplus is maximized if consumers who value the tickets at or above the equilibrium price, PE, go to the concert (those on the top portion of the demand curve between point E and the y-axis). The consumers who value the tickets at a price between PE and $150 (those between points E and B along the demand curve), will purchase tickets through Ticketmaster. 12. Uber has long been criticized for its use of surge pricing, setting prices based on current supply and demand factors, which, at times, results in a sudden and drastic increase in prices. In a Wall Street Journal article, the CEO of Uber was asked if we are seeing the end of surge pricing. His response: “. . . at the end of the day, Friday night is three or five times bigger than a Sunday night in any city around the world. And if you’ve got enough supply on the system so that we were perfectly supplied on a Friday night for as much demand as a city could ever throw at us, then the rest of the week you have drivers not making a living.” a. Draw a demand and supply graph for Uber rides in Miami on a Sunday night. How does demand change on a Friday night? How does the supply of Uber rides change? Label the shortage of Uber cars that results on a Friday night without surge pricing. b. Show what happens to consumer and producer surplus on a Friday night without surge pricing. c. How does surge pricing change consumer and producer surplus? 12. a. Price of Uber rides S U Ph Pf PS V Y E3 Z E1 W X A Shortage DS QS Qf Df Qa Quantity of Uber rides In the figure, the demand curves for Uber rides on Sunday and Friday nights are labeled Ds and D f, respectively. Without surge pricing the supply of Uber rides is the same for both nights. This leaves a shortage of Uber cars on Friday night equal to the difference between Qa and Qs. b. As shown in the figure in part a, without surge pricing Uber will charge Ps. Consumer surplus for Uber rides on Friday night is equal to area U + V + W. Producer surplus is area X. c. With surge pricing, Uber will increase price to P f and the quantity of rides supplied will increase to Q f. Under surge pricing, consumer surplus is equal to area U + V + Y and producer surplus is equal to W + X + Z. 13. Hollywood screenwriters negotiate a new agreement with movie producers stipulating that they will receive 10% of the revenue from every rental of a movie they wrote. They have no such agreement for movies shown on on-demand television. a. When the new writers’ agreement comes into effect, what will happen in the market for movie rentals—that is, will supply or demand shift, and how? And, as a result, how will consumer surplus in the market for movie rentals change? Illustrate with a diagram. Do you think the writers’ agreement will be popular with consumers who rent movies? b. Consumers consider movie rentals and on-demand movies substitutable to some extent. When the new writers’ agreement comes into effect, what will happen in the market for on-demand movies—that is, will supply or demand shift, and how? And, as a result, how will producer surplus in the market for on-demand movies change? Illustrate with a diagram. Do you think the writers’ agreement will be popular with the cable television companies that show on-demand movies? c. More consumers are shifting their movie-watching preferences from Redbox rentals to streaming services like Netflix and Amazon Prime. What will happen in the market for movie rentals after the shift in movie preferences? How will producer surplus in the market for movie rentals change? Illustrate with a diagram. How will the shift to streaming movies affect movie rental companies and Hollywood screenwriters? 13. a. The payment to writers will increase the cost of providing movie rentals. In the accompanying diagram, the supply curve shifts leftward from S1 to S2, the equilibrium price of movie rentals rises from P1 to P2, and the quantity of movie rentals bought and sold falls from Q1 to Q2. As a result, consumer surplus will decrease by the shaded amount. The writers’ agreement will not be popular with consumers. Price of movie rental S2 P2 S1 E2 P1 E1 D Q2 Q1 Quantity of movie rentals b. The higher price of movie rentals will make on-demand movies more popular. They are substitute goods, and the demand for them will increase when the price of movie rentals rises. In the accompanying diagram, the demand curve shifts rightward from D1 to D2, the equilibrium price rises from P1 to P2, and the equilibrium quantity rises from Q1 to Q2. Producer surplus will increase by the shaded amount. This change will be popular with the cable and satellite television companies that show on-demand movies. Price of on-demand movie S P2 E2 E1 P1 D1 Q1 D2 Q2 Quantity of on-demand movies c. As consumers watch more streaming movies, the demand for movie rentals will decrease. In the accompanying diagram, the demand curve shifts leftward from D1 to D2, the equilibrium price of movie rentals falls from P1 to P2, and the quantity of movie rentals bought falls from Q1 to Q2. Producer surplus will decrease by the shaded amount. The decrease in producer surplus will lower the revenue for movie rental companies, causing some to go out of business. With fewer movie rentals, screenwriters will see a reduction in their incomes. Price of movie rentals S P1 E1 E2 P2 D2 Q2 D1 Q1 Quantity of movie rentals WORK IT OUT Interactive step-by-step help with solving this problem can be found online. 14. The accompanying diagram shows the demand and supply curves for taxi rides in New York City. Price (dollars per mile) $5.00 S 3.50 2.50 1.83 E1 E2 1.30 0.50 0 (after D Uber) 240 400 600 D 840 1,200 Quantity of taxi rides (millions of miles) a. At E1 the market is at equilibrium with 600 million miles of rides transacted at an equilibrium price of $2.50. Calculate consumer surplus, producer surplus, and total surplus at E1. b. Uber’s entry into the market reduces the quantity of rides demanded from taxis by 30% at every price, shifting the demand curve leftward. Assume that New York City politicians respond by imposing a regulated price of $2.50 per mile. Calculate consumer surplus, producer surplus, and total surplus for the taxi market after Uber has entered the market. c. After complaints from riders, New York removes the regulated price of $2.50 per mile. What happens to the equilibrium price and quantity? How will taxi drivers and riders be affected? 14. a. At a price of $2.50 per mile and a quantity of 600 million rides consumer surplus is ½ × ($5.00 - $2.50) × (600 million) = $750 million, producer surplus is ½ × ($2.50 - $0.50) × 600 million = $600 million, and total surplus is $750 million + $600 million = $1,350 million. b. At a regulated price of $2.50 per mile, the new quantity demanded is 240. Consumer surplus is now ½ × ($3.50 - $2.50) × 240 million = $120 million. Producer surplus is (($2.50 - $1.30) × 240 million) + (½ × ($1.30 - $0.50) × 240 million) = $288 million + $96 = $384 million. Total surplus is $120 million + $384 million = $504 million. c. With Uber in the market, removing the price regulations for taxis in New York City will allow the taxi market to return to a new equilibrium at a price of $1.83 per mile and a quantity of 400 million rides. In the absence of price regulation on taxi rides, riders will be made better off as both consumer surplus and total surplus increase. Taxi drivers, however, will be made worse off as producer surplus decreases as both price and quantity of taxi rides fall. Solution Manual for Microeconomics Paul Krugman, Robin Wells 9781319098780
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