Chapter 5: Efficiency and Equity

Question 1

What is the difference between demand, willingness to pay, and value?

Answer 1

• Value is what we get, and the price is what we pay.
• The value of one more unit of a good or service is its marginal benefit.
• We measure value as the maximum price that a person is willing to pay. But the willingness to pay determines demand.
• A demand curve is a marginal benefit curve.

Question 2

What is consumer surplus?

Answer 2

• Consumer surplus is the excess of the benefit received from a good over the amount paid for it.
• We calculate consumer surplus as the marginal benefit (or value) of a good minus its price, summed over the quantity bought.
• It is measured by the area under the demand curve and above the price paid, up to the quantity bought.

Question 3

What are supply, cost, and minimum supply prices?

Answer 3

• Cost is what the producer gives up, and the price is what the producer receives.
• The cost of one more unit of a good or service is its marginal cost. Marginal cost is the minimum price that a firm is willing to accept. But the minimum supply price determines supply.
• A supply curve is a marginal cost curve.

Question 4

What is the difference between cost and price?

Answer 4

• Cost is typically the expense incurred for making a product or service that is sold by a company.
• Price is the amount a customer is willing to pay for a product or service.

Question 5

What does it mean shortage and surplus in the market?

Answer 5

• A surplus exists when the price is above equilibrium, which encourages sellers to lower their prices to eliminate the surplus.
• A shortage will exist at any price below equilibrium, which leads to the price of the good increasing.

Question 6

What is producer surplus?

Answer 6

• Producer surplus is the excess of the amount received from the sale of a good over the cost of producing it.
• We calculate it as the price received for a good minus the minimum-supply price (marginal cost), summed over the quantity sold.
• On a graph, producer surplus is shown by the area below the market price and above the supply curve, summed over the quantity sold.
• Producer surplus is the total amount that a producer benefits from producing and selling a quantity of a good at the market price.

Question 7

What are externalities? Give some examples, results, and solutions.

Answer 7

• An externality is a cost or benefit that affects someone other than the seller or the buyer of a good. So they will not take it into account when making a decision.
• Examples of negative externality: airplane travel leaves a carbon footprint, and industrial waste in rivers.
• As a result of negative externalities, we produce too much.
• Solution: make people pay for their action
• Example of positive externalities: if you get an education other people will benefit too, if you wash your hand and avoid getting ill others will benefit too).
• As a result of positive externalities, is underproduction.
• Solution: make people benefit more from their action

Question 8

What are public goods and common resources?

Answer 8

• A public good benefits everyone and no one can be excluded from its benefits.
  For example, national defense, a park, information, asteroid defense system, and global warming.
  It is in everyone’s self-interest to avoid paying for a public good (called the free-rider problem), which leads to underproduction.
• As a solution, it is often provided by the government.
• A common resource is owned by no one but can be used by everyone but it is rival in usage.
  For example, *a lake with fish, roads, and wildlife.
  *It is in everyone’s self-interest to ignore the costs of their own use of a common resource that falls on others (called the tragedy of the commons). The tragedy of the commons leads to overproduction.
• As a solution there needs to be legal restrictions on usage.***