Question

Jo was in the market for a used car when she first moved to Melbourne. She spent many hours walking around at Car City looking for one. She found that the salespeople were overly friendly and asked her lots of questions about her life, which frankly, were none of their business. Why were the salespeople doing this? How do you think this information affected the price of the car? Jo had a budget in mind and ended up paying her top price for a car. What does this mean? How does this outcome affect producer and consumer surplus? What about society as a whole?

Answer 1

Salespeople were doing this to gather as much knowedge as possible about Jo's ability to buy. Such questions result in asymmetric informoration where the salespeople know about the consumer's income and the details of cars they are about to offer. On the other hand, the consumer does not have perfect information about everything.

If Jo ended up paying her top price, Jo was charged her reservation price. A reservation price is the highest price that a buyer is willing to pay.

This outcome decreases consumer surplus to zero. Consumer surplus is the difference between what a consumer is willing to pay versus what they actually end up paying. In this case, there will no consumer surplus. Producer surplus will increase since the seller was able to sell at the highest price possible. Producer surplus is the difference between the price seller offers and the actual price he receives.

The net benefit of society as a whole increases if the gain in producer surplus exceeds the loss in consumer surplus. The net benefit of society as a whole decreases if the the loss in consumer surplus exceeds the gain in producer surplus.