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Principles of Microeconomics

7th Edition
N. Gregory Mankiw
ISBN: 9781305156050

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Principles of Microeconomics

7th Edition
N. Gregory Mankiw
ISBN: 9781305156050
Textbook Problem

Jen values her time at $60 an hour. She spends 2 hours giving Colleen a massage. Colleen was willing to pay as much at $300 for the massage, but they negotiate a price of $200. In this transaction,

a. consumer surplus is $20 larger than producer surplus.

b. consumer surplus is $40 larger than producer surplus.

c. producer surplus is $20 larger than consumer surplus.

d. producer surplus is $40 larger than consumer surplus.

To determine
The consumer surplus and the producer surplus.

Answer

Option 'a' is correct.

Explanation

The equilibrium price is determined by the demand for the cost and the supply of cost, normally. The consumer surplus can be explained as the difference between the highest price that the consumer is willing to pay and the actual price that the consumer pays. The difference between these two prices is known as the surplus to the consumer. The producer surplus is the difference between the minimum willing to accept price by the seller and the actual price that the seller receives for the commodity.

The maximum willing to pay price by the consumer for the massage here is $300. The actual price that the consumer pays after the negotiation between the two is $200. Since the difference between the maximum willing to pay price and the actually paying price is the consumer surplus, it can be calculated as follows:

Consumer surplus=Maximum willing to pay priceActually paying price=300200=100

Thus, the consumer surplus is $100.

Similarly, the minimum willing to accept price by the massager is $60 per hour and she spends 2 hours for the service, which totally costs $120, minimum. But the actual amount received by her is $200; this difference between the actual price received by the seller and the minimum willing to accept price is the producer surplus, which can be calculated as follows:

Producer surplus=Actually received priceMinimum willing to accept price=200(60×2)=200120=80

Thus, the producer surplus is $80.

Option (a):

Here, the consumer surplus is $100 from receiving the massage from the producer and the producer surplus is $80 by providing the massage service to the consumer. The difference between the consumer surplus and the producer surplus is $20. This means that the consumer surplus is higher than the producer surplus by $20 and hence, option 'a' is correct.

Option (b):

Here, the consumer surplus is $100 from receiving the massage from the consumer and the producer surplus is $80 by providing the massage service to the consumer. This means that the consumer surplus is higher than the producer surplus by only $20. But the given value in option 'b' is $40, which is twice the actual value. Thus, option 'b' is incorrect.

Option (c):

The consumer surplus is $100 from receiving the massage from the consumer and the producer surplus is $80 by providing the massage service to the consumer. This means that the consumer surplus is higher than the producer surplus by $20. Option 'c' points that the producer surplus is higher than the consumer surplus by the value of $20, which is inverse to the actual situation. Thus, option 'c' is incorrect.

Option (d):

The consumer surplus is $100 from receiving the massage from the producer and the producer surplus is $80 by providing the massage service to the consumer. The difference between the consumer surplus and the producer surplus is $20. The consumer surplus is $20 more than the producer surplus. Since option 'd' argues that the producer surplus is $40 larger than the consumer surplus, option 'd' is incorrect.

Concept

Concept introduction:

Consumer surplus: It is the difference between the highest willing to pay price of the consumer and the actual price that the consumer pays.

Producer surplus: It is the difference between the lowest willing to accept price by the producer and the actual price that is received by the producer.

Equilibrium price: It is the market price determined by equating the supply to the demand. At this equilibrium point, the supply will be equal to the demand and there will be no excess demand or excess supply in the economy. Thus, the economy will be at equilibrium.

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