Question

Explain why Qm does not maximize the total surplus in the economy. (Answer this in words but also to make the point numerically, calculate TS at Qso) d. What is the Deadweight Loss? e. What can the government do to correct the problem? Explain how we know this. c. 2. (Taken from Mankiw Question 6 Chapter 10) The many identical residents of Whoville love drinking Zlurp. Each resident has the following willingness topay for the tasty refreshment: First bottle Second bottle Third bottle $5 $4 $3 $2 Fourth bottle Fifth bottle Further bottles a The cost of producing Zlurp is $1.50, and the competitive suppliers sell it at this price. (The supply curve is horizontal or perfectly elastic.) How many bottles will each Whovillian consume? What is cach person's consumer surplus? b. Producing Zlurp creates pollution. Each bottle has an external cost of SI. Taking this additional cost into account, what is total surplus per person in the allocation you described in part (a)? e. Cindy Lou Who, one of the residents of Whoville decides on her own to reduce her consumption of Zlurp by one bottle. What happens to Cindy's welfare (her consumer surplus minus the cost of the pollution she experiences? How does Cindy's decision affect total surplus in Whoville? d. Mayor Grinch imposes a $1 tax on Zlurp. What is consumption per person now? Calculate consumer surplus, the external cost, government revenue and total surplus per person. e Based on your calculations, would you support the mayor's policy? Why or why not? Open Word

Answer 1

2)i) The cost of producing a bottle is $1.50. Based on this , the consumers would each consume 4 bottles. The consumer surplus would be Consumer's willingness to pay- price paid

=$5+4+3+2-(4*1.50)= $14-6=$8

b) Since 4 bottles are consumed an additional cost of $4 would be subtracted from it , hence would give the answer as

Consumer surplus(new)=$8-4=$4.

c)If Cindy is reducing her consumption by 1 bottle, her consumer surplus woulf be

$5+4+3-(1.5*3)=12-4.5=$7.50

So her consumer surplus had reduced by $0.50

As we know there is an additional cost of$1 per bottle, so that would be reduced and hence total change in consumer surplus would be

Change in total Surplus= Increase of surplus due to consumption of one less bottle- decreased consumer surplus of Cindy.

=$1-0.5=$0.50

d)If each bottle has an additional tax of $1, then the cost of total bottles would be $4.

Now each bottle would cost $1 extra. So the cost would be $2.50

Hence the consumer would buy 3 bottles and consumer surplus wohld be $12-7.50=$4.50

Revenue to government would be $1*3=$3

External cost would be $3 and the total surplus would also be $4.50

Total surplus= consumer s+ government surplus- external cost =$4.50-3+3=$4.50

e) The mayor's decision is correct because in this case the consumer surplus is more than without tax ie $4.

(You can comment for doubts)