Question

2. Suppose that demanders demand 195 widgets at a price of $21, and demand 240 widgets at a price of $20. What is the PED over this segment of the demand curve?
a. 4.241
b. 0.832
c. 6.714
d. 0.395
3. Following up on question 2 above, which of the following best explains what will occur should widget manufacturers decide to decrease the price they charge for widgets?
a. Revenues will decrease because PED is elastic
b. Revenues will increase because PED is elastic
c. Revenues will not change because PED is unit elastic
d. Need more information
4. Suppose that the market price of lawn chairs is $16.01. Will needs a lawn chair and is willing to pay $18 for a chair. ChairCo is a manufacturer of lawn chairs. ChairCo’s cost for manufacturing a chair is $14. Should Will and ChairCo do business, and if so how much surplus will each enjoy?
a. Yes, Will may realize $1.99 of consumer surplus and ChairCo will realize $2.01 of producer surplus
b. No, the price is too high
c. No, ChairCo’s profits will decline if it sells the chair to Will
d. Yes, Will may realize $18 of consumer surplus and ChairCo will realize $14 of producer surplus
5. True or false. Economists consider market equilibrium efficient because at equilibrium Consumer Surplus is maximized whereas Producer Surplus is not.
a. True
b. False

Answer 1

Q2. When P1 = $21, Q1 = 195

When P2 = $20, Q2 = 240

Using the midpoint method:

% change in price = {(P2-P1)/[(P1+P2}/2} * 100 = {($20-$21)/[($21+$20)/2]} * 100 = {(-1)/20.5} * 100 = -4.878%

% change in quantity demanded = {(Q2-Q1)/[(Q1+Q2)/2]} * 100 = {(240-195)/[(195+240)/2]} * 100 = {45/217.5} * 100 = 20.690%

Price elasticity of demand = % change in quantity demanded/% change in price = 20.690/(-4.878) = -4.241 (Negative sign can be dropped as the PED is generally negative as a consequence of the law of demand)

Ans: a. 4.241

Q3. As the price elasticity of demand is greater than 1, the demand is elastic. When the demand is elastic, a unit percentage increase in price causes a greater decrease in the quantity demanded and hence, the total revenue decreases. Similarly, when the price decreases, the total revenue increases.

Ans: b. Revenues will increase because PED is elastic

Q4. Market price = $16.01

Cost to manufacturer = $14

Will's willingness to pay = $18

Producer Surplus = Market price - Cost to manufacturer = $1.01 - $14 = $2.01

Consumer Surplus = Willingness to pay - Market price = $18 - $16.01 = $1.99

As both consumer and producer have a positive surplus, they should participate in business.

Ans: a. Yes, Will may realize $1.99 of consumer surplus and ChairCo will realize $2.01 of producer surplus

Q5. The market equilibrium is considered efficient as the equilibrium ensures the maximum total surplus in the market. If the price is not equal to the market equilibrium price, there will be deadweight losses in the market and thus the total surplus decreases.

It is to be noted that at the market equilibrium, both the consumer surplus and the producer surplus are not maximized. It is the total surplus that is maximized.

Ans: b. False