Question

There are six potential consumers of computer games, each willing to buy only one game. Consumer 1 is willing to pay $$ 40\( for a computer game, consumer 2 is willing to pay \)\ 35\(, consumer 3 is willing to pay \)\$ 30, consumer 4 is willing to pay \(\$ 25, consumer 5 is willing to pay \)\$ 20, and consumer 6 is willing to pay \(\$ 15. a. Suppose the market price is \)\$ 29 . What is the total consumer surplus? b. The market price decreases to \(\$ 19 . What is the total consumer surplus now? c. When the price falls from \)\$ 29\( to \)\$ 19$, how much does each consumer's individual consumer surplus change? How does total consumer surplus change?

Short answer

a. The total consumer surplus at a market price of \(29 is \)11 + \(6 + \)1 = \(18. b. At a market price of \)19, the total consumer surplus is \(55. c. Each consumer's surplus increases except for consumer 5 whose surplus remains \)1; the total consumer surplus increases by $37.

Step-by-step solution

Understanding Consumer Surplus

Consumer surplus is the difference between what consumers are willing to pay for a good or service (their reservation price) and what they actually pay (market price). To find the total consumer surplus, sum the individual surpluses of each consumer who pays less than their reservation price.

Calculate Total Consumer Surplus at \(29

Identify consumers with reservation prices above the market price of \)29. Those are consumers 1, 2, and 3. Their surpluses are \(40 - \)29 = \(11 for consumer 1, \)35 - \(29 = \)6 for consumer 2, and \(30 - \)29 = \(1 for consumer 3. Sum these amounts to get the total consumer surplus at this price.

Calculate Total Consumer Surplus at \)19

With the market price now at \(19, consumers 1 through 5 are willing to purchase. Calculate their individual surpluses: \)40 - \(19 = \)21 for consumer 1, \(35 - \)19 = \(16 for consumer 2, \)30 - \(19 = \)11 for consumer 3, \(25 - \)19 = \(6 for consumer 4, and \)20 - \(19 = \)1 for consumer 5. Add these up for the total consumer surplus.

Calculate Change in Individual Consumer Surplus

To calculate the change in each consumer's surplus, subtract their surplus at the new price from their surplus at the original price. Consumers who did not purchase at the higher price now have a surplus equal to their reservation price minus the new price. For each consumer who bought at both prices, the change in surplus is the difference in their surpluses across the two prices.

Calculate the Change in Total Consumer Surplus

Subtract the total consumer surplus calculated at the original price from the total consumer surplus calculated at the new price. This amount represents the change in total consumer surplus when the market price decreases.

Key concepts

Microeconomics

Microeconomics is a branch of economics that focuses on the behavior of individuals and firms in making decisions regarding the allocation of scarce resources and the interactions among these individuals and firms. It looks at the factors that influence individual choices, such as prices, the allocation of resources, and the regulation of markets.

The concept of consumer surplus, as presented in our exercise, is a fundamental microeconomic concept that illustrates how individuals perceive value and how they benefit from market transactions. In the context of microeconomics, understanding consumer surplus is essential for analyzing economic efficiency, market outcomes, and the overall welfare impact of different policies on consumers.

Microeconomics also delves into the supply and demand model, which is pivotal for determining market prices and quantities sold in the market. This model is directly related to the exercise, as the demand curve is closely tied to consumers' willingness to pay, which represents their reservation prices.

Market Price

Market price is the price at which a good or service is bought and sold in a market. It is determined by the interaction of supply and demand for that good or service. Market price is not static; it fluctuates based on various factors such as availability, production costs, and consumer preferences.

In our exercise, the market price is a crucial element when calculating consumer surplus. It's the benchmark against which we measure what consumers are willing to pay. A change in the market price, as seen when it drops from \(29 to \)19, directly affects the consumer surplus because it changes the amount consumers pay for the computer games. The market price is also a signal that guides the decisions of buyers and sellers; a high market price might suggest a scarcity of goods, while a low market price might indicate a surplus or a decrease in demand.

Reservation Price

The reservation price is the maximum price a consumer is willing to pay for a particular good or service. It is an individual’s personal valuation of the good, based on their preferences, income, and the utility derived from consuming the good. Everyone's reservation price is different, reflecting their subjective value of the good.

In the textbook exercise, each consumer’s reservation price is explicitly stated. Consumer surplus occurs when the market price is lower than a consumer's reservation price, allowing consumers to pay less for the good than they would be willing to pay, which translates into a benefit or surplus for them. Understanding reservation prices is key in calculating consumer surpluses and comprehending market dynamics; it helps to chart a demand curve, inform pricing strategies, and predict how consumers will react to price changes.

Demand

Demand refers to the quantity of a product or service that consumers are willing and able to purchase at various prices during a certain period of time. It is represented graphically by the demand curve, which is typically downward sloping, indicating that as the price decreases, the quantity demanded increases—and vice versa.

Our exercise with the consumers and computer games is a direct application of demand principles. Each consumer’s willingness to pay represents a point on the demand curve for computer games. As the market price changes, the quantity of games demanded also changes, which is illustrated by the consumers’ decisions to buy or not buy the game at different prices. Understanding demand is crucial as it helps explain consumer behavior in markets and can show how a change in price can lead to a change in the total consumer surplus.