Amherst College Department of Economics Economics 111 Section 5 Fall 2015 Micro Handout 8: Consumer and Producer Surplus

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1 Amherst ollege epartment of Economics Economics 111 Section 5 all 2015 Micro Handout 8: onsumer and roducer Review: Tax Incidence Begin at the initial, no tax, equilibrium and move left until the vertical gap between the market demand and supply curves equals the tax, $.40 per gallon. The associated quantity is the new equilibrium quantity: ** = 7,500. The point on the demand curve is the new equilibrium price from the perspective of the consumer, ** = 2.40, and the point of the supply curve represents the new equilibrium price from the perspective of the firms, ** = ($/gallon) 2.50 * * = * = 2.10 * * = ,000 Tax = $.40 7, ** = 7,500 7,750 * = 8,000 (thousands of gallons per day) S When you follow these three steps the two conditions are satisfied: Because the vertical gap between the demand and supply curves is $.40, the price from the perspective of the consumer and the price from the perspective of the firm differ by $.40: ** = **.40 The quantity demanded equals the quantity supplied; when the price from the perspective of consumers equals **, the quantity demanded is ** and when the price from the perspective of firms equals **, the quantity supplied equals ** also: = ** = 2.00 = ** = 2.40 uantity supplied = ** = 7,500 uantity demanded = ** = 7,500 uestion: Why do we move to the left rather than the right?? So now, we can summarize how the imposition of a tax affects the market: The equilibrium quantity decreases; The price from the perspective of consumers increases, but by less than the full amount of the tax; The price from the perspective of firms decreases, but by less than the full amount of the tax. The burden of the tax is shared by consumers and firms. uestion: How can we quantify the burden borne by consumers and firms?

2 2 Six Introductory Economics Students Who Are onsidering Hiring a Tutor Greatest Amount a Student Would ay to Hire Tutoring ($/tutor) Student Services Andy $ Kate 225 an 175 Liz Meg 75 Ned 25 emand urve for Tutors: How many students would hire a tutor if the tutor s price was, given that everything else relevant to the demand for tutors remains 50 the same. (Tutors) Revealed reference: An individual s decisions reveal the value he/she places on the good. When the price of a good is $xxx, if an individual, call him Joe, ã é does purchase the good does not purchase the good Joe values the benefits of the Joe values the benefits of the good by than $xxx. good by than $xxx. Joe s Value of Benefits $xxx Joe s Value of Benefits $xxx uestion: By how much does a student value the benefits of tutoring services? laim: The value a student Greatest amount the places on the benefits equals student would pay of tutoring services for tutoring services To justify the claim focus on Andy: The greatest amount Andy would pay for tutoring services is $275. If the price of tutoring services were $275: If the price of tutoring services were $276: Andy purchase tutoring services. Andy purchase tutoring services. Value Andy places on the benefits Value Andy places on the benefits of tutoring benefits $275 of tutoring benefits $276 é ã Value Andy places on the benefits of tutoring equals $. uestion: Why do the values differ from student to student?

3 3 onsumer surplus equals the net benefit students receive from tutoring services: The sum of the benefit each student receives for tutoring services less what he/she pays. Value of Net Benefit of Receiving Tutoring Services Student Tutoring Benefits If price = $ If price = $ If price = $50 Andy $275 Kate 225 an 175 Liz Meg 75 Ned 25 onsumer onsumer : The net benefit buyers enjoy from purchasing and consuming the good. Height of Market emand urve: Reflects the benefit a buyer enjoys from consuming a specific unit of the good. onsumer : The benefit each buyer enjoys from consuming the good less what each buyer must pay for the good. Area Beneath the Market emand urve Lying Above the rice: Reflects all the net benefits buyers enjoy, the consumer surplus, from purchasing and consuming the good. rice onsumer Market emand urve for Tutors ($/tutor) Andy Kate an Liz Meg Ned (Tutors)

4 4 Six Economics Majors Who Are onsidering roviding Tutoring Services Least Amount Required to Induce Each Major to Student rovide Tutoring Services Kim $275 John 225 Adam Lisa 125 Walt 75 Beth 25 ($/tutor) 300 Supply urve for Tutors: How many majors would agree to be a tutor if the tutor s price was, given that everything else relevant to the supply of tutors remains the same. 50 (Tutors) uestion: What is each major s opportunity cost of providing tutoring services? laim: The value of a major s The least amount required opportunity cost of equals to induce the major to providing tutoring services provide tutoring services To justify this claim, consider Beth s opportunity cost of providing tutoring services. Review uestion: In general, what does opportunity cost represent? Answer: Whatever is when an activity is pursued. uestion: What would Beth forego if she were to provide tutoring services? Answer: uestion: What is the value of Beth s opportunity cost of providing tutoring services? Answer: uestion: By how much does Beth value this Other Activity? What do we know about Beth? The least amount required to induce Beth to provide tutoring services is $25. If the price of tutoring services were $24: If the price of tutoring services were $25: Beth provide tutoring services. Beth provide tutoring services. Beth pursue the Other Activity. Beth pursue the Other Activity. Value Beth places on the benefits Value Beth places on the benefits of the Other Activity $24. of the Other Activity $25 é ã Value Beth places on the benefits of the Other Activity is $. Beth s opportunity cost of providing tutoring services is $.

5 5 uestion: Why do the opportunity costs differ from major to major? roducer surplus equals the net benefit majors receive from providing tutoring services: The sum of what each major receives for his/her tutoring services less his/her opportunity cost. Opportunity ost Least Amount Required to Induce a Major to Net Benefit of roviding Tutoring Services Major rovide Tutoring Services If price = $50 If price = $ If price = $ Kim $275 John 225 Adam Lisa 125 Walt 75 Beth 25 roducer roducer : The net benefit sellers enjoy from producing and selling the good. Height of Market Supply urve: The seller s opportunity cost of providing a specific unit of the good. roducer : What each seller receives from the sale of the good less the opportunity cost each seller incurs by providing it. Area Above the Market Supply urve Lying Beneath the rice: Reflects all the net benefit sellers enjoy, the producer surplus, from producing and selling the good. Market Supply urve for Tutors ($/tutor) Beth Walt Lisa Adam John Kim 300 S 50 (Tutors) roducer S rice

6 6 Summary onsumer : The net benefit buyers enjoy from purchasing and consuming the good. Height of Market emand urve: Reflects the benefit a buyer enjoys from consuming a specific unit of the good. onsumer : The benefit each buyer enjoys from onsumer consuming the good less what each buyer must pay for the good. Area Beneath the Market emand urve Lying Above the rice: Reflects all the net benefits buyers enjoy, the rice consumer surplus, from purchasing and consuming the good. roducer : The net benefit sellers enjoy from producing and selling the good. Height of Market Supply urve: The seller s opportunity cost of providing a specific unit of the good. roducer : What each seller receives from the sale roducer of the good less the opportunity cost each seller incurs by providing it. Area Above the Market Supply urve Lying Beneath the rice rice: Reflects all the net benefit sellers enjoy, the producer surplus, from producing and selling the good. S