Syeda Umyma Faiz

ERP: 25895
Institute of Business Administration,
Karachi Principles of Microeconomics
Session: Fall 2022
Assignment # 3
Instructions: Show your calculations and graphs for the questions below. For essay
questions/questions asking for explanation/description, please submit answers using no
more than 5 lines (only computer written will be accepted). These questions are from the
Mankiw’s book, copying anything from the online resources may lead to expulsion from
the program. Therefore, do not try to copy the words or style of explanation from the web.
The plagiarism policy will be applied strictly and with full force. If you do refer to a source,
please provide proper citation, the best policy, however is to use your own words (the best
thing you can do to avoid any plagiarism). Please submit a hard copy on Saturday the 5th
November 2022.

1. Melissa buys an iPhone for $240 and gets consumer surplus of $160.
a) What is her willingness to pay?

Mellissa’s willingness to pay is $240 + $160 = $400.

b) If she had bought the iPhone on sale for $180, what would her consumer surplus
have been?

If she had bought the iPhone on sale for $180, her consumer surplus would increase to
($400 - $180) $220.

c) If the price of an iPhone were $500, what would her consumer surplus have been?

With price of $500 and Melissa’s willingness to pay being $400, there will be no
consumer surplus.

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2. An early freeze in California sours the lemon crop. Explain what happens to consumer
surplus in the market for lemons. Explain what happens to consumer surplus in the
market for lemonade. Illustrate your answers with diagrams.

As the lemon crop sours, the supply of lemon decreases, shifting the supply curve to the left.
This leads to an increase in the price of lemons and decrease in the quantity demanded.
Hence, the consumer surplus decreases.

The lemons and lemonade are complementary goods as lemons are a raw material for the
production of lemonade. The decrease in the supply of lemon leads to a decrease in supply
of lemonade, hence a fall in the consumer surplus.

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3. It is a hot day, and Bert is thirsty. Here is the value he places on each bottle of water:

Value of first bottle $7

Value of second bottle $5
Value of third bottle $3
Value of fourth bottle $1

a) From this information, derive Bert’s demand schedule. Graph his demand curve for
bottled water.

Price of Quantity of
Bottles $ Bottles
Demanded
$7 1
$5 2
$3 3
$1 4

b) If the price of a bottle of water is $4, how many bottles does Bert buy? How much
consumer surplus does Bert get from his purchases? Show Bert’s consumer surplus in
your graph.

Bert buys 2 bottles of water at $4. The consumer surplus is shown by the area A in the
diagram.
Consumer Surplus: (2 x 1) + (1 x 2) = 2 + 2 = $4

c) If the price falls to $2, how does quantity-demanded change? How does Bert’s
consumer surplus change? Show these changes in your graph.

Bert buys 2 bottles of water at $4 and 3 bottles of water at $2. Therefore, the change in
quantity-demanded is (3-2) 1. The total consumer surplus is shown by Area A+B.
Total Consumer surplus: A= (2 x 1) + (1 x 2) = 2 + 2 = $4
B= (2 x 1) + (1 x 3) = 2 + 3 = $5
Total Consumer surplus = $4 + $5 = $9
The change in consumer surplus is shown by the area B in the diagram.
Change in Consumer Surplus: B=$5.

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4. Ernie owns a water pump. Because pumping large amounts of water is harder than
pumping small amounts, the cost of producing a bottle of water rises as he pumps
more. Here is the cost he incurs to produce each bottle of water:

Cost of first bottle $1

Cost of second bottle $3
Cost of third bottle $5
Cost of fourth bottle $7

a) From this information, derive Ernie’s supply schedule. Graph his supply curve for
bottled water.

Price of Quantity of
Bottles $ Bottles Supplied
$1 1
$3 2
$5 3
$7 4

b) If the price of a bottle of water is $4, how many bottles does Ernie produce and sell?
How much producer surplus does Ernie get from these sales? Show Ernie’s producer
surplus in your graph.

Ernie produces and sells 2 bottles of water at $4. The producer surplus is shown by the area
A in the diagram.
Producer Surplus: (3 x 1) + (1 x 1) = 3 + 1 = $4

c) If the price rises to $6, how does quantity-supplied change? How does Ernie’s
producer surplus change? Show these changes in your graph.

Ernie produces and sells 2 bottles of water at $4 and 3 bottles of water at $6. Therefore, the
change in quantity-supplied is (3-2) 1. The total producer surplus is shown by Area A+B.
Total producer surplus: A= (3 x 1) + (1 x 1) = 3 + 1 = $4
B= (2 x 2) + (1 x 1) = 4 + 1 = $5
Total Consumer surplus = $4 + $5 = $9
The change in consumer surplus is shown by the area B in the diagram.
Change in Consumer Surplus: B=$5.

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 5. Consider a market in which Bert from problem 3 is the buyer and Ernie from problem
4 is the seller.

a) Use Ernie’s supply schedule and Bert’s demand schedule to find the quantity supplied
and quantity demanded at prices of $2, $4, and $6. Which of these prices brings
supply and demand into equilibrium?

Price $ Quantity Supplied Quantity Demanded

2 1 3
4 2 2
6 3 1

The price $4 brings supply and demand into equilibrium with the equilibrium quantity being 2.

b) What are consumer surplus, producer surplus, and total surplus in this equilibrium?

Consumer surplus = $4
Producer surplus = $4
Total surplus = $4 + $4 = $8

c) If Ernie produced and Bert consumed one fewer bottle of water, what would happen
to total surplus?

If Ernie produces one fewer bottle of water, the producer surplus would decrease to $3, as
shown in the graph of Q4, at quantity supplied of 1, the price is $3. Hence, the producer
surplus is (1 x 3) $3.
If Bert buys one fewer bottle of water, the consumer surplus would decrease to $3, as
shown in the graph of Q3, at quantity demanded of 1, the price is $6. Hence, the consumer
surplus is (1 x 3) $3.
The total surplus will decrease to (3 + 3) $6.

d) If Ernie produced and Bert consumed one additional bottle of water, what would
happen to total surplus?

If Ernie produces one additional bottle of water, the producer surplus would decrease by $1,
as shown in the graph of Q4, at quantity supplied of 3, the cost is $5. Hence, the cost
exceeds the price by $1.
If Bert buys one additional bottle of water, the consumer surplus would decrease by $1, as
shown in the graph of Q3, at quantity demanded of 3, the price is $3. Hence, the consumer
the price that Bret is willing to pay is $1 less than that of the equilibrium price.
The total surplus will decrease by (1 + 1) $2.

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6. One of the largest changes in the economy over the past several decades is that
technological advances have reduced the cost of making computers.

a) Draw a supply-and-demand diagram to show what happened to price, quantity,

consumer surplus, and producer surplus in the market for computers.

b) Forty years ago, students used typewriters to prepare papers for their classes;
today they use computers. Does that make computers and typewriters complements
or substitutes? Use a supply-and-demand diagram to show what happened to price,
quantity, consumer surplus, and producer surplus in the market for typewriters.
Should typewriter producers have been happy or sad about the technological
advance in computers?

Computers and typewriters are substitutes of each other.

The typewriter producers should be sad about the technological advancement in

computers as the increase in production and demand for computers, decrease the
quantity demanded for its substitutes, which is in this case, the typewriters. This shifts
the demand curve to the left, decreasing the producer surplus.

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c) Are computers and software complements or substitutes? Draw a supply-and-
demand diagram to show what happened to price, quantity, consumer surplus,
and producer surplus in the market for software. Should software producers have
been happy or sad about the technological advance in computers?

Computers and software are complementary goods.

The technological advancement in computers will open market for the software
producers. Thus, the demand for software will increase, shifting the demand curve to the
right. This will result in increase in the producer surplus for the software. The producers
for software should be happy.