ASSIGNMENT NO. 1

Economics

SUBMITTED TO

Ma’am Ayesha Naseem

SUBMITTED BY

Sehrish Afzal

6145-FMS/MBA/F13

MBA-27-A

Date: 21-5-2014

Q: 01

Explain consumer surplus and producer surplus?

Ans: Producer surplus

An economic measure of the difference between the amount that a producer of a good receives and the minimum amount that he or she would be willing to accept for the good. The difference, or surplus amount, is the benefit that the producer receives for selling the good in the market.

For example,

A producer is willing to sell 500 widgets at $5 a piece and consumers are willing to purchase these widgets for $8 per widget. If the producer sells all of the widgets to consumers for $8, it will receive $4,000. To calculate the producer surplus, you subtract the amount the producer received by the amount it was willing to accept, (in this case $2,500), and you find a producer surplus of $1,500 ($4,000 - $2,500).

Consumer surplus

An economic measure of consumer satisfaction, which is calculated by analysing the difference between what consumers are willing to pay for a good or

service relative to its market price. A consumer surplus occurs when the consumer is willing to pay more for a given product than the current market price.

Consumers always like to feel like they are getting a good deal on the goods and services they buy and consumer surplus is simply an economic measure of this satisfaction.

For example, assume a consumer goes out shopping for a CD player and he or she is willing to spend $250. When this individual finds that the player is on sale for $150, economists would say that this person has a consumer surplus of $100.

Economic welfare

Economic welfare is the total benefit available to society from an economic transaction or situation. Economic welfare is also called community surplus. Welfare is represented by the area ABE in the diagram below, which is made up of the area for consumer surplus, ABP plus the area for producer surplus, PBE.

In market analysis economic welfare at equilibrium can be calculated by adding consumer and producer surplus. Welfare analysis considers whether economic decisions by individuals, organisations, and the government increase or decrease economic welfare.

Price discrimination and consumer & producer surplus

Price discrimination occurs when a firm charges a different price to different groups of consumers for an identical good or service, for reasons not associated with the costs of supply. Is price discrimination something that economists should be supporting in terms of the behaviour of businesses and final outcomes in different markets?

Pure (1st degree) discrimination

With 1st degree price discrimination the firm is able to perfectly segment the market so that the consumer surplus is removed and turned into producer surplus. Thus there is a clear transfer of welfare from consumers to producers. This is shown in the next diagram.

Third degree (or multi-market) price discrimination involves charging different prices for the same product in different segments of the market. The key is that third degree discrimination is linked directly to consumers’ willingness and ability to pay for a good or service. It means that the prices charged may bear little or no relation to the cost of production. Clearly the price elasticity of demand is the key factor determining the pricing decision for producers for each part of the market.

Q: 02

Explain efficiency, gain and dead weight loss in monopoly and perfect competition?

Ans: PERFECT COMPETITION

There should not be any deadweight loss in a perfectly competitive market because in perfect competition, market equilibrium is reached when marginal revenue is equal to marginal cost which is equal to the going price. Recall from supply/demand diagram that marginal revenue is the demand curve and marginal cost is the supply curve. Firms in perfect competition are price-takers, they cannot influence the price, and each firm must accept same, going price to stay in business. If they raise the price, no one wants to buy something that expensive when they can get it cheaper elsewhere so the firm goes out of business.

If they decrease the price, the firm loses profit and must go out of business. So a perfectly competitive firm must accept the market price. This price is equal to

marginal revenue which is also equal to marginal cost at the price, quantity location on your diagram. When marginal revenue is equal to marginal cost, what we gain is what we pay out, so there is no long-run profit and there is no deadweight loss because our firm is not losing or gaining anything in the long run, yet society has many businesses to supply similar products at the same price. This is efficient (no deadweight loss) because marginal cost is equal to the going price which is equal to marginal revenue or MC=MR=P (this is necessary for perfect competition to occur).

Deadweight losses may occur through legislation, lobbying for market power, or no rules against monopolies and oligopolies in which cases the price is above marginal cost because the monopolists/oligopolies have the power to raise the price above marginal cost. This creates a deadweight loss to society. Also, certain taxes can shift supply and demand which creates deadweight losses as well.

MONOPOLY:

The outcome of a competitive market has a very important property. In equilibrium, all gains from trade are realized. This means that there is no additional surplus to obtain from further trades between buyers and sellers. In this situation, we say that the allocation of goods and services in the economy is efficient. However, markets sometimes fail to operate properly and not all gains from trade are exhausted. In this case, some buyer surplus, seller surplus, or both are lost. Economists call this a deadweight loss. The monopolist produces a quantity such that marginal revenue equals marginal cost. The price is determined by the demand curve at this quantity.

The deadweight loss from the tax measures the sum of the buyer’s lost surplus and the seller’s lost surplus in the equilibrium with the tax. The total amount of the deadweight loss therefore also depends on the elasticity of demand and supply. The smaller these elasticity, the closer the equilibrium quantity traded with a tax will be to the equilibrium quantity traded without a tax, and the smaller is the deadweight loss.