Consumer Surplus 1. What is Willingness to Pay (WTP), (which is also known as reservation price)?

The maximum amount a buyer is willing to pay for a good or service. 2. What is consumer surplus? The reservation price of a consumer subtracted by the price the consumer paid for the good. 3. How are willingness to pay and consumer surplus related? The more a consumer is willing to pay, the higher the consumer surplus is when the consumer purchases the item for a certain price. 4. How can you create a demand curve based on reservation prices? Graph the quantity of goods vs. the buys reservation prices. As the quantity increases, the willingness to pay gradually decreases. 5. Who is the marginal buyer? The buyer who would not buy the good if the price were any higher. 6. Using a demand curve, how would you find the WTP of the purchaser of the 5th unit? Look at the price of the fifth horizontal portion of the graph from the left. 7. If you draw a horizontal line (representing price) that intersects the demand curve, how do you find consumer surplus? Area under the consumer willingness to pay line on the demand graph and above the horizontal price line. 8. How does consumer surplus change as price increases? Decreases? What are the two components of the change in consumer surplus? 9. How can we use consumer surplus to measure the benefits of a market transaction (a purchase)? a. Why might consumer surplus be a better measure of the benefits of a transaction than having government determine which products or services are most beneficial to consume? b. When might individual preferences fail to give a good measure of societys benefits from a market transaction? 10. Can society benefit from for-profit activities just as much, or more, than from volunteer activities? Producer Surplus (PS) What is included in producers costs? What is PS and how is it related to cost? How can you create a supply curve based on sellers costs? Who is the marginal seller? Using a supply curve, how would you find the cost of the 5th unit? If you draw a horizontal line (representing price) that intersects the supply curve, how do you find producer surplus? How does producer surplus change as price increases? Decreases? What are the two components of the change in producer surplus?

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18. How can we use producer surplus to measure the benefits of a market transaction (a purchase)? a. When might producer surplus fail to give a good measure of societys benefits from a market transaction? 19. What is Total Surplus (TS)? What does it measure? 20. Draw a supply and demand diagram. Find the market price. Label CS, PS, and TS. 21. How is TS used to measure economic efficiency? 22. What does TS tell us about the fairness of a market outcome? 23. In a market economy, who gets to consume? a. Who gets to produce? b. What quantity gets produced? c. Suppose we changed any of the above, what will happen to TS? 24. Read the Adam Smith quotes on slides 41 and 42 of the Powerpoint slides for Chapter 7. 25. In anticipation of our next chapter (Chapter 10), consider what would be the efficiency consequences if the supply curve did not reflect all costs of production or if the demand curve did not reflect the true benefits of consumption.