Tutorial Questions
Chapter 2: Consumer and Producer Surplus, Efficiency, and Taxation
The following questions give you practice in calculating and illustrating consumer
surplus, producer surplus, the deadweight loss from an excise tax, and the gain or loss in total
surplus that results from a market outcome. Attempt each question before checking the
worked answer that follows it.
Question 1 — Willingness to Pay and Consumer Surplus
Five students are potential buyers of a second-hand laptop. The table below shows
each buyer's willingness to pay for the laptop, listed from highest to lowest.
Buyer Willingness to Pay ($)
Zara 70
Ben 55
Chloe 40
Dara 28
Ei Ei 15
Suppose the market price of a second-hand laptop is $35.
(a) Which buyers will purchase a laptop at this price? Explain why the others do not buy.
(b) Calculate the individual consumer surplus received by each buyer who purchases a laptop.
(c) Calculate the total consumer surplus generated in this market.
(d) Draw the (step-shaped) demand curve for this market and shade the area that represents
consumer surplus.
Answer:
(a) A rational buyer purchases only if his or her willingness to pay is at least equal to
the price. Since the price is $35, Zara ($70), Ben ($55), and Chloe ($40) all buy a laptop,
because their willingness to pay exceeds $35. Dara ($28) and Ei Ei ($15) do not buy,
because their willingness to pay is below the $35 price — buying would make them worse
off.
(b) Individual consumer surplus = Willingness to Pay − Price paid:
Zara: $70 − $35 = $35
Ben: $55 − $35 = $20
Chloe: $40 − $35 = $5
(c) Total consumer surplus = $35 + $20 + $5 = $60.
(d) The diagram below shows the step-shaped demand curve. The shaded rectangles
above the $35 price line and below the demand curve represent the consumer surplus earned
by Zara, Ben, and Chloe.
Figure 1: Consumer surplus at a price of $35 (shaded area = $60)
Question 2 — Cost and Producer Surplus
Five students are potential sellers of a second-hand laptop. The table below shows
each seller's cost — the lowest price at which each is willing to sell — listed from lowest to
highest.
Seller Cost ($)
Aung 8
Bo 18
Cho 28
Dwe 38
Eaint 48
Suppose the market price of a second-hand laptop is $30.
(a) Which sellers will sell a laptop at this price? Explain why the others do not sell.
(b) Calculate the individual producer surplus received by each seller who sells a
laptop.
(c) Calculate the total producer surplus generated in this market.
(d) Draw the (step-shaped) supply curve for this market and shade the area that
represents producer surplus.
Answer:
(a) A rational seller sells only if the price is at least equal to his or her cost. Since the
price is $30, Aung ($8), Bo ($18), and Cho ($28) all sell, because their cost is below $30.
Dwe ($38) and Eaint ($48) do not sell, because their cost exceeds the $30 price — selling
would make them worse off.
(b) Individual producer surplus = Price received − Cost:
Aung: $30 − $8 = $22
Bo: $30 − $18 = $12
Cho: $30 − $28 = $2
(c) Total producer surplus = $22 + $12 + $2 = $36.
(d) The diagram below shows the step-shaped supply curve. The shaded rectangles
below the $30 price line and above the supply curve represent the producer surplus earned by
Aung, Bo, and Cho.
Figure 2: Producer surplus at a price of $30 (shaded area = $36)
Question 3
— Excise Tax, Tax Incidence, and Deadweight Loss
The demand and supply for hotel rooms in a small town are given by the following
equations, where P is the price per room (in dollars) and Q is the quantity of rooms rented per
night:
Demand: Qd = 100 − 2P
Supply: Qs = 2P − 20
(a) Find the equilibrium price and quantity before any tax is imposed.
(b) The government now imposes an excise tax of $8 per room on hotel owners (the
sellers). Write the new, post-tax supply equation, in terms of the price paid by consumers, P.
(c) Find the new equilibrium quantity, the price paid by consumers, and the price
received by producers net of tax.
(d) Calculate the tax revenue collected by the government.
(e) Calculate the deadweight loss caused by the tax.
(f) Illustrate your answers on a demand-and-supply diagram.
Answer:
(a) Setting quantity demanded equal to quantity supplied:
100 − 2P = 2P − 20 ⟹ 120 = 4P ⟹ P = $30
Substituting back: Q = 100 − 2(30) = 40.
The pre-tax equilibrium is price = $30 and quantity = 40 rooms per night.
(b) The $8 tax means that, for every price P paid by consumers, hotel owners now
keep only (P − 8). Since sellers previously supplied 2P − 20 at price P, they will supply the
same quantity only if they now receive an extra $8, so the supply curve shifts up by the
amount of the tax:
Qs (post-tax) = 2(P − 8) − 20 = 2P − 36
(c) Setting demand equal to the new post-tax supply:
100 − 2P = 2P − 36 ⟹ 136 = 4P ⟹ P = $34
This $34 is the price paid by consumers. The equilibrium quantity is Q = 100 −
$8 = $26. (Check: at P = $26, Qs = 2(26) − 20 = 32 ✓.)
2(34) = 32 rooms per night. The price received by producers (net of the $8 tax) is $34 −
(d) Tax revenue = tax per unit × quantity sold = $8 × 32 = $256.
(e) The deadweight loss is the value of the mutually beneficial transactions (40 − 32
= 8 rooms) that no longer take place because of the tax. It is the area of the triangle between
the pre-tax and post-tax quantities:
Deadweight Loss = ½ × Tax × (Q₀ − Q₁) = ½ × $8 × (40 − 32) = ½ × $8 × 8 = $32
(f) The diagram below shows the pre-tax equilibrium (E), the upward shift of the
supply curve by the amount of the tax, the new price paid by consumers ($34) and received
by producers ($26), the tax revenue rectangle ($256), and the deadweight-loss triangle ($32).
Figure 3: Effect of an $8 excise tax — price, quantity, tax revenue, and deadweight loss
Question 4 — Market Efficiency and the Cost of Misallocation
In a competitive market for a good, the equilibrium price is $40. At this price:
• Ana is willing to pay $50 for one unit, and she buys at the market price.
• Bob is willing to pay only $35 for one unit, and he does not buy at the market price.
• Xavier's cost of producing one unit is $32, and he sells at the market price.
• Yamin's cost of producing one unit is $48, and she does not sell at the market price.
(a) Explain why Ana buys while Bob does not, and why Xavier sells while Yamin
does not.
(b) Suppose a policy-maker reallocates consumption: the unit is taken away from
Ana and given to Bob instead. Calculate the resulting change in total consumer surplus.
(c) Suppose instead the policy-maker reallocates sales: Xavier is prevented from
selling and Yamin is compelled to sell instead. Calculate the resulting change in total
producer surplus.
(d) Suppose instead the policy-maker simply prevents the transaction between
Xavier (seller) and Ana (buyer) from taking place at all. Calculate the loss in total surplus.
(e) What general principle about the efficiency of competitive markets do your
answers to (b)–(d) illustrate?
Answer:
(a) Ana's willingness to pay ($50) exceeds the market price ($40), so buying makes
her better off; Bob's willingness to pay ($35) is below the price, so buying would make him
worse off. Xavier's cost ($32) is below the market price, so selling makes him better off;
Yamin's cost ($48) exceeds the price, so selling would make her worse off. The market
equilibrium automatically directs consumption toward the buyer who values the good most,
and sales toward the seller who can produce it most cheaply.
(b) The unit is worth $50 to Ana but only $35 to Bob. Moving it from Ana to Bob
therefore reduces total consumer surplus by: $50 − $35 = $15
(c) Xavier can produce the unit for $32, but Yamin's cost is $48. Forcing Yamin to
produce instead of Xavier raises the cost of supplying that unit and therefore reduces total
producer surplus by: $48 − $32 = $16
(d) Preventing the Xavier–Ana transaction destroys a mutually beneficial trade: Ana
valued the unit at $50, while Xavier's cost was only $32. The total surplus that would have
been created by this trade — and that is now lost — is: $50 − $32 = $18
(e) These results illustrate that a competitive market equilibrium is efficient: it (i)
allocates the good to the buyers who value it most, (ii) allocates production to the sellers with
the lowest cost, and (iii) ensures that every mutually beneficial trade takes place and no
others do. Any policy that reallocates consumption, reallocates sales, or changes the quantity
traded away from the market equilibrium can only reduce total surplus — it can never
increase it.
Figure 4: Reallocating consumption or production away from equilibrium reduces total surplus