Question

1. Suppose a market has only one seller and only one buyer of a good in the market. The buyer is willing to pay $50 for the good and the seller is willing to accept $15. The market price of the good is determined at $30. If they trade, the social surplus will be ________.

A) $15 B) $35 C) $45 D) $65

2. Many industry-wide studies of the elasticity of demand for cigarettes (an industry dominated by a few firms with tremendous market power) indicate a price elasticity near – 0.5. Yet, our study of market power tells us that a firm with any market power at all should never operate at a point on its demand curve where demand is inelastic. How can you reconcile these apparently contradictory statements?

Answer 1

Solution 1:

Money buyer is willing to pay = $50

Money seller is willing to accept = $15

Market price = $30

Consumer surplus = Money buyer is willing to pay - Market price that he is paying

Consumer surplus = $50-$30 = $20

Seller surplus = Money seller is getting - Money seller is willing to accept

Seller surplus = $30-$15 = $15

Social surplus = Consumer surplus + Seller surplus

Social surplus = $20+$15 = $35

Therefore option B) is the right answer