Question

2. Draw a graph to illustrate why a price increase can cause a larger reduction in consumer surplus when demand is more elastic. (your graph will have two demand curves, one that is relatively more elastic than the other, and one supply curve)

3. Suppose that the production function for rubbing alcohol is R = f(L, K). When L = 4 and K = 6 then R = 10. Is it possible that L = 3 and K = 6 also produces R = 10? Why or why not?

Answer 1

Solution to Question 2 :

Consumer surplus can be measured or calculated by the area under the demand curve and above the price line. The initial Cunsumer surplus is above the equilibrium price line in both the graphs. The new consuner surplus which is the result of same change in price can be seen to be unequal between the two. In graph 1, the loss in consumer surplus is greater than the loss in consumer surplus in graph 2.

In Graph 1, demand curve is elastic, which means a small price change brings a greater change in quantity demanded. Due to this, a small rise is price offsets demand more than proportionally. Hence, the consumer surplus is greater in this case.

On the other hand,in graph 2, the demand is relatively inelastic and the rise in price brings a smaller change in demand. Due to this, the same change in price results in lower loss in consumer surplus.

For a better understanding two graphs are used but the supply, change in price, axes and everything except the demand curves are kept more or less same.

NOTE : As per our guideline, in the case of multiple questions without specification as to which question needs to be solved, the first question is answered.