Efficiency and Fairness of Markets

6 Efficiency and Fairness of Markets CHECKPOINTS

Checkpoint 6.1 Checkpoint 6.2 Checkpoint 6.3 Clicker version Problem 1 Problem 1 Problem 1 Problem 2 Problem 2 Problem 2 Problem 3 Problem 3 Problem 3 Problem 4 Problem 4 Problem 4 Problem 5 Problem 5 Problem 5

Checkpoint 6.4 Checkpoint 6.5 Problem 1 Problem 1 Clicker version Problem 2 Problem 2 Clicker version Problem 3 Problem 3 Problem 4 Problem 4 Problem 5

Practice Problem 1 Which method is used to allocate the following scarce resources? Campus parking space between student areas and faculty areas A spot in a restricted student parking area Textbooks Host city for the Olympic Games CHECKPOINT 6.1

Solution Campus parking is allocated by command. Thespot in a restricted student parking area is allocated on a first-come, first-served basis. Textbooks are allocated by market price (sharing). The Olympic Games is allocated by contest. CHECKPOINT 6.1

Study Plan Problem Which method is used to allocate campus parking space between student areas and faculty areas? A. Command B. First-come, first-served C. Contest D. Market price E. Majority rule CHECKPOINT 6.1

Which method is used to allocate a spot in a restricted student parking area? A. Command B. Market price C. Contest D. First-come, first-served E. Majority rule CHECKPOINT 6.1

Which method is used to allocate textbooks? A. Command B. Market price C. Contest D. First-come, first-served E. Majority rule CHECKPOINT 6.1

Which method is used to allocate the host city for the Olympic Games? A. Command B. Market price C. Contest D. First-come, first-served E. Majority rule CHECKPOINT 6.1

Practice Problem 2 The figure shows a nation’s PPF and Table 2 shows its marginal benefit and marginal cost schedules. What is the marginal benefit from bananas when 1 pound of bananas is grown? What is the marginal cost of growing 1 pound of bananas? CHECKPOINT 6.1

Solution Marginal benefit is the amount of coffee that the nation is willing to give up to get one additional banana. The marginal benefit from bananas is 3 pounds of coffee. Marginal cost is the amount of coffee that the nation must give up to get one additional banana. The marginal cost of growing 1 pound of bananas is 1 pounds of coffee. CHECKPOINT 6.1

Practice Problem 3 The figure shows a nation’s PPF and the table shows the marginal benefit and marginal cost schedules. On the figure, mark a point of production efficiency, but with too much coffee produced to be a point of allocative efficiency. CHECKPOINT 6.1

Solution Point A on the figure shows production efficiency (on PPF) but not allocative efficiency. Because with 1 banana, marginal benefit does not equal the marginal cost of a banana (from table). Because marginal benefit from a banana exceeds marginal cost of a banana, too few bananas are produced. CHECKPOINT 6.1

Practice Problem 4 The figure shows a nation’s PPF and Table 2 shows its marginal benefit and marginal cost schedules. On the figure, mark the nation’s point of allocative efficiency, point B. CHECKPOINT 6.1

Solution Point B on the figure is the point of allocative efficiency because it is on the PPF and when the quantity of bananas is 2 pounds, marginal benefit frim a banana equals the marginal cost of a banana (from the table). CHECKPOINT 6.1

Practice Problem 5 AC/DC’s “Black Ice” tour breaks records down under The tour promoters reported that the 40,000 tickets for the March 6 gig in Perth, Australia, sold out in seven minutes—a record. Many people who camped out overnight missed getting a ticket. Source: WAToday, May 25, 2009 What is the method used to allocate AC/DC concert tickets? When the March 6 gig sold out, promoters announced a March 8 gig, with tickets going on sale two days later. Was the allocation of tickets efficient? CHECKPOINT 6.1

Solution First-come, first-served is used to allocate AC/DC concert tickets. The allocation was efficient if the willingness to pay (the ticket price plus the opportunity cost of the buyer’s time), which is also the marginal benefit, equaled the marginal cost of providing one more seat. CHECKPOINT 6.1

Practice Problem 1 The figure shows the demand curve for DVDs and the market price of a DVD. What isthe willingness to pay for the 20th DVD? What is the value of the 10th DVD and the consumer surplus on the 10th DVD? CHECKPOINT 6.2

Solution The willingness to pay for the 20th DVD is the price on the demand curve at 20 DVDs, which is $15. The value of the 10th DVD is its marginal benefit, which also is the maximum price that someone is willing to pay for it. The value of the 10th DVD is $20. CHECKPOINT 6.2

The consumer surplus on the 10th DVD is its marginal benefit minus the price paid for the DVD. The length of the green arrow in the figure shows the consumer surplus on the 10th DVD. The consumer surplus on the 10th DVD is $20  $15, which equals $5. CHECKPOINT 6.2

Practice Problem 2 The figure shows the demand curve for DVDs and the market price of a DVD. What is the quantity of DVDs bought and what is the consumer surplus on DVDs? What is the amount spent on DVDs and what is thetotal benefit from the DVDs bought? CHECKPOINT 6.2

Solution The quantity of DVDs bought is 20 a day. The consumer surplus is the area of the green triangle, which equals($25 - $15) x 20 ÷ 2. Consumer surplus is $100. CHECKPOINT 6.2

The amount spent on DVDs is the price multiplied by the quantity bought, which is the area of the blue rectangle. The amount spent equals $15 x 20 = $300. The total benefit from DVDs is the amount spent on DVDs ($300) plus the consumer surplus from DVDs ($100), which is $400. CHECKPOINT 6.2

Practice Problem 3 The figure shows the demand curve for DVDs and the market price of a DVD. If the price of a DVD rises from $15 to $20, what is the change in consumer surplus? CHECKPOINT 6.2

Solution If the price of a DVD rises to $20, the quantity of DVDs bought decreases to 10 a day. The consumer surplus decreases to the area of the green triangle, which is ($25  $20) x 10 ÷ 2. The consumer surplus is $25. The consumer surplus decreases by $75 (from $100 to $25). CHECKPOINT 6.2

Practice Problem 4 Online travel agencies drop ticket booking fees Online airline ticket agents have dropped the $7 booking fee and expedia.com and priceline.com have also dropped the $50 cancelation fee. Expedia.com reports that its ticket sales have increased by double-digits. Source: USA Today, June 3, 2009 Distinguish between the price of a flight and the value of a flight before the fees were dropped. CHECKPOINT 6.2

Solution The price of a flight is what you pay the travel agent—the price of the airline ticket plus the booking fee. The value of a flight is the marginal benefit you get from using the airline ticket. CHECKPOINT 6.2

Practice Problem 5 Online travel agencies drop ticket booking fees Online airline ticket agents have dropped the $7 booking fee and expedia.com and priceline.com have also dropped the $50 cancelation fee. Expedia.com reports that its ticket sales have increased by double-digits. Source: USA Today, June 3, 2009 With the removal of the booking fee, how have the price and the consumer surplus from flights changed? CHECKPOINT 6.2

Solution The removal of the booking fee decreases the price of a flight. The quantity of flights demanded increases —a movement down along the demand curve for flights. Consumer surplus equals the value (marginal benefit) minus the price of a flight, summed over the number of flights bought. Marginal benefit minus the price of a flight has increased, so the consumer surplus from any one flight has increased. With more flight bought, the consumer surplus has increased. CHECKPOINT 6.2

Practice Problem 1 The figure shows the supply curve for DVDs and the market price of a DVD. What isthe minimum supply price of the 20th DVD? What is the marginal cost of the 10th DVD and the producer surplus on the 10th DVD? CHECKPOINT 6.3

Solution The minimum supply price of the 20th DVD is the marginal cost of the 20th DVD which is $15. The marginal cost of the 10th DVD is equal to the minimum supply price for the 10th DVD which is $10. CHECKPOINT 6.3

The producer surplus on the 10th DVD is the market price minus the marginal cost of producing the 10th DVD. The length of the blue arrow in the figure shows the producer surplus on the 10th DVD. The producer surplus on the 10th DVD is $15  $10, which equals $5. CHECKPOINT 6.3

Practice Problem 2 The figure shows the supply curve of DVDs and the market price of a DVD. What is the quantity of DVDs sold and what is the producer surplus on DVDs? What is the total revenue from DVDs and what is the cost of producing the DVDs sold? CHECKPOINT 6.3

Solution The quantity of DVDs sold is 20 a day. The producer surplus is the area of the blue triangle, which equals($15 - $5) x 20 ÷ 2. Producer surplus is $100. CHECKPOINT 6.3

The total revenue is the price multiplied by the quantity sold, which is the area of the blue triangle plus the red area. The total revenue equals $15 x 20 = $300. The total cost of producing DVDs is the red area, which equals the total revenue ($300) minus the producer surplus from DVDs ($100), which is $200. CHECKPOINT 6.3

Practice Problem 3 The figure shows the supply curve of DVDs and the market price of a DVD. If the price of a DVD falls from $15 to $10, what is the change in producer surplus? CHECKPOINT 6.3

Solution If the price of a DVD falls to $10, the quantity of DVDs produced decreases to 10 a day. The producer surplus, the area of the blue triangle, decreases to ($10 – $5) x 10 ÷ 2, which is $25. The change in producer surplus is a decrease of $75 (from $100 down to $25). CHECKPOINT 6.3

Practice Problem 4 Dealership has less than a week to sell all its cars Chrysler is shutting 800 dealerships and they must be closed by June 9, 2009. O’Bryhim, a dealer in Virginia, today sold a new Nitro at a discount of 40 percent—$17,510 instead of the regular price of $29,170. As June 9 approaches, O’Bryhim expects he will have to increase the discount and mark prices down further to sell all the cars on his lot. Source: CNN.com, June 3, 2009 Distinguish between the price of a new car and the cost of the car. CHECKPOINT 6.3

Solution The price of a new car is the amount received by the car dealership when it is sold—the regular price minus the discount. The dealer’s cost of a new car (the marginal cost of a car) is what the dealer paid Chrysler (the manufacturer) for the car. CHECKPOINT 6.3

Practice Problem 5 Dealership has less than a week to sell all its cars Chrysler is shutting 800 dealerships and they must be closed by June 9, 2009. O’Bryhim, a dealer in Virginia, today sold a new Nitro at a discount of 40 percent—$17,510 instead of the regular price of $29,170. As June 9 approaches, O’Bryhim expects he will have to increase the discount and mark prices down further to sell all the cars on his lot. Source: CNN.com, June 3, 2009 If next week, O'Bryhim increases the discount to 50 percent, how will the producer surplus on a new Nitro change? CHECKPOINT 6.3

Solution The producer surplus on a new Nitro is the price O'Bryhim receives for the Nitro when it is sold minus O'Bryhim’s cost of the Nitro. As the discount increases, the price received falls and the producer surplus decreases. CHECKPOINT 6.3

Practice Problem 1 The figure shows the market for paper. At the market equilibrium, what are the consumer surplus, producer surplus, and total surplus? Is the market for paper efficient? Why or why not? CHECKPOINT 6.4

Solution Market equilibrium is 40 tons a day at a price of $3 a ton. Consumer surplus equalsthe area of the green triangle, which is $(9 – 3) x 40 ÷ 2.Consumer surplus is $120. Producer surplus equals the area of the blue triangle, which is ($3 - $1) x 40 ÷ 2.Producer surplus is $40. CHECKPOINT 6.4

Total surplus is the sum of consumer surplus ($120) and producer surplus ($40), which is $160. The market is efficient because marginal benefit (on the demand curve) equals marginal cost (on the supply curve) and total surplus is maximized. CHECKPOINT 6.4

Practice Problem 2 The figure shows the market for paper. A news magazine lobbying group persuades the government to pass a law that requires producers to sell 50 tons of paper a day. Is the market for paper efficient? Why or why not? CHECKPOINT 6.4

Solution The market is inefficient because at the quantity 50 tons a day, marginal cost exceeds marginal benefit. Deadweight loss equals the area of the gray triangle 1 in the figure. CHECKPOINT 6.4

Practice Problem 3 The figure shows the market for paper. An environmental lobbying group persuades the government to pass a law that limits the quantity of paper that producers sell to 20 tons a day. Is the market efficient? Why or why not? What is the deadweight loss? CHECKPOINT 6.4

Solution This market is now inefficient because at a quantity of 20 tons of paper a day, marginal benefit exceeds marginal cost. Deadweight loss equals the area of the gray triangle 2 in the figure. CHECKPOINT 6.4

Practice Problem 4 National parks to offer free-entry weekends Interior Secretary Ken Salazar has urged everyone to visit the national parks over the weekends of June 20-21, July 18-19, and August 15-16 when admission will be free. Kathy Kupper, spokeswoman for the National Parks Service, said that she couldn’t remember the fee having been waived in more than 20 years. Source: Los Angeles Times, June 3, 2009 How will waiving the admission charge influence consumer surplus? CHECKPOINT 6.4

Efficiency and Fairness of Markets