Difficulty level:

Challenging

LECTURE 13
Consumer Surplus and Producer Surplus 30 mins

Government Intervention 45 mins

Final Review 45 mins

Group Presentations 60 mins

1
 SMU Classification: Restricted

Where are we?

Short Run Long Run

Equilibrium Price Determined by market ?

supply and demand

Profit >,<,or =0 ?

Quantity ? ?
COR2100 2
 SMU Classification: Restricted

Where are we?

Perfectly Competitive Monopoly (or Near Monopoly)

Industry Fragmented Concentrated: Single Firm
Structure
Pricing Price Takers Price Makers
Barriers to No Barriers to Entry Significant Barriers to Entry
Entry
Koryolink (North Korea’s only 3G
Natural Gas Rigs, Agricultural mobile provider), Singapore Power,
Examples Sectors Microsoft, Some Specialized
Medical Services 3
 SMU Classification: Restricted

Self evaluation on class participation

• Peer Evaluation of Team Members

• Peer Evaluation
• Finish by 14 Nov (Sun)

COR2100 4
 SMU Classification: Restricted
Rubric for Class Participation
Limited participation Acceptable participation
1-3 marks 4-5 marks
Student is present and Student is present and
tries to be attentive in attentive in class e.g. pays
class. The student rarely attention to the instructor’s
participates in class exposition and to peer’s
discussions. comments, takes down notes
when necessary. The student
makes an effort to contribute
to class discussions e.g. by
making a genuine effort to
think and answer questions.
COR2100
Good participation
6-7 marks
Student is present and
attentive in class e.g. pays
attention to the instructor’s
exposition and to peer’s
comments, takes down
notes when necessary. The
student contributes actively
to class discussions e.g. by
asking clarification
questions when unclear
about class content or
offering some insights that
promote understanding of
the course material.
Excellent participation
8-10 marks
Student is present and
attentive in class e.g. pays
attention to the
instructor’s exposition
and to peer’s comments,
takes down notes when
necessary. The student
contributes actively to
class discussions e.g. by
offering some major
insights that promote
understanding of the
course material and raises
the motivation and level
5
of learning of peers.
Part 1
Consumer surplus and Producer surplus

6
 SMU Classification: Restricted

How to measure the change in satisfaction level

when price changes?
• When the price of a good decreases

• When the price of a good increases

• How to quantify the benefit or loss due to a change in price?

• Consumer surplus

COR2100 7
 SMU Classification: Restricted

Why is measuring consumer welfare important?

• SingTel, Starhub, and M1: merge and become one firm

• How to evaluate the potential merger?

• Costs

• Benefits

• Estimate the potential damage to the consumers due to higher prices

COR2100 8
 SMU Classification: Restricted

Consumer Surplus

• Difference between the consumer’s willingness to pay for a product and the
cost of purchasing the product
• Willing to pay 1 million to buy a house
• Actually paid 0.8 million
• CS is 0.2 million

• CS is the area below the demand curve and above the price

COR2100
 SMU Classification: Restricted

Example: Willingness to Pay for Candy

• $0.9 for the first candy

• $0.7 for the second candy
• $0.5 for the third candy
• $0.1 for the fourth candy

COR2100
 SMU Classification: Restricted

Example: Willingness to Pay for Candy

COR2100 11
 SMU Classification: Restricted

Example: Willingness to Pay for Candy

Suppose the price of candy is $0.3

COR2100 12
 SMU Classification: Restricted

Consumer Surplus with Smooth Demand Curve

The current price is $20

CS=0.5*80*(100-20)=$3,200

COR2100 13
 SMU Classification: Restricted

Change in Consumer Surplus

Suppose the price rises from $20 to $30

CS decreases by $750

COR2100 14
 SMU Classification: Restricted

Producer Surplus

• Difference between the amount producers actually receive by producing and

selling a certain unit and the amount producers have to receive to produce a
certain unit

• PS is the area below the price and above the supply curve

COR2100
 SMU Classification: Restricted

Example: PS in the market for houses

• 3 construction firms
• Each firm can only build 1 house in a year

• Firm 1 cost=0.4 million

• Firm 2 cost=0.5 million
• Firm 3 cost=0.6 million

• Suppose the market price is 0.7 million

COR2100 16
 SMU Classification: Restricted

Example: PS in the market for houses

PS=0.7-0.4+0.7-0.5+0.7-0.6=0.6

COR2100 17
 SMU Classification: Restricted

Producer Surplus for Smooth Supply Curve

PS=0.5*80*(40-10)=$1,200

COR2100 18
 SMU Classification: Restricted

Total Surplus (CS+PS)

• Efficient market outcome

• Total surplus is maximized

• Not efficient market outcome

• Total surplus is not maximized
• Suffer from deadweight loss (=net loss in total surplus)

COR2100 19
 SMU Classification: Restricted

Discussion Question: Moon Travel

• In 2040 you start a firm, MoonTravel, that offers trips to the moon
• First firm to offer this service and you face no direct competition

COR2100 20
 SMU Classification: Restricted

Discussion Question: Moon Travel

Hi, I am Jerry. I am willing to pay 18 million

Hi, I am Tom. I am willing to pay 12 million

Hi, I am Tyke. I am willing to pay 2 million

COR2100 21
 SMU Classification: Restricted

Discussion Question: Moon Travel

• How much should Moon Travel charge Jerry, Tom and Tyke?

COR2100 22
 SMU Classification: Restricted

First-degree/Perfect price discrimination

• Charge each consumer at his/her willingness to pay

COR2100 23
 SMU Classification: Restricted

First-degree/Perfect price discrimination

• CS?

COR2100 24
 SMU Classification: Restricted

Price Discrimination

• Charging different prices to different consumers for the same good

• Second-degree price discrimination

• Quantity discount
• Buy two get 15% discount

• Third-degree price discrimination

• Different prices for different segments/ groups of consumers

COR2100 25
 SMU Classification: Restricted

Examples of Third-degree price

discrimination
• Age
• Senior discount, student discount

• Gender
• Ladies’ night in bars and clubs

• Geographical location
• Staples charges different prices based on where the online shoppers live (by postal code)

• Mac users vs. PC users in the future?

• Orbitz (online travel agency) recommends pricier hotels to Mac users
 SMU Classification: Restricted

Be able to price discrimination: 2 conditions

• A product that can not be resold

• Identify and separate different buyer types

COR2100 27
Part 2
Government Intervention

28
 SMU Classification: Restricted

Progressive Tax System = Redistribute Income to

Address Fairness Issues
• Average tax rate=Total taxes divided by total income

• Marginal tax rate=The rate paid on the last dollar of income

• Average and marginal tax rates are higher for households with higher
income

COR2100 29
 Progressive Tax System (US tax year 2020)
If your taxable income is between Your tax bracket is

$0 and $9,875 (9,875 - 0) × 10 percent 10 percent

$9,875 and $40,125 (40,125-9,875) × 12 percent 12 percent
$40,125 and $85,525 (60,000 – 40,125) × 22 percent
22 percent
$85,525 and $163,300 24 percent
$163,300 and $207,350 32 percent
$207,350 and $518,400 35 percent
$518,400 and above 37 percent
 Progressive Tax System (US tax year 2020)
(9,875 - 0) × 10 percent= $987.50
+ (40,125-9,875) × 12 percent= $3,630
+ (60,000 – 40,125) × 22 percent = $4,372.5
total = $8,990
Average tax rate: $8,990 / $60,000 = 14.98 %
Marginal tax rate=?
 Discussion Question: Income=$120K
If your taxable income is between Your tax bracket is
$0 and $9,875 10 percent
$9,875 and $40,125 12 percent
$40,125 and $85,525 22 percent
$85,525 and $163,300 24 percent
$163,300 and $207,350 32 percent
$207,350 and $518,400 35 percent
$518,400 and above 37 percent

Suppose your taxable income is $120,000

 Case of SG: Progressive
 Chargeable Income
On the first 20,000 0 Tax System
Rate (%) Gross Tax Payable ($)
0
On the next 10,000 2 200
On the first 30,000 - 200
On the next 10,000 3.50 350
On the first 40,000 - 550
On the next 40,000 7 2,800
On the first 80,000 - 3,350
On the next 40,000 11.5 4,600
On the first 120,000 - 7,950
On the next 40,000 15 6,000
On the first 160,000 - 13,950
On the next 40,000 18 7,200
On the first 200,000 - 21,150
On the next 40,000 19 7,600
On the first 240,000 - 28,750
On the next 40,000 19.5 7,800
On the first 280,000 - 36,550
On the next 40,000 20 8,000
On the first 320,000 - 44,550
In excess of 320,000 22
 SMU Classification: Restricted

Welfare Analysis

• No government intervention (tax and subsidy)

• TS =CS + PS

• With government
• TS =CS + PS + tax revenue collected – subsidy paid

COR2100 34
 SMU Classification: Restricted

Tax incidence

• Who bears the burden of a tax

• How the burden of taxation is distributed

COR2100 35
 SMU Classification: Restricted

Tutorial Section: $3 tax per hat

Price Supply Demand $3 tax on sellers
$0 0 120 CS, PS, DWL
$1 10 100 What fraction of the $3
$2 20 80 tax is paid by the buyers?
$3 30 60
$3 tax on buyers
$4 40 40
CS, PS, DWL
$5 50 20 What fraction of the $3
$6 60 0 tax is paid by the buyers?

COR2100 36
 SMU Classification: Restricted

$3 Tax on Producers
Tax on Producers
Before Tax After Tax
P consumers pay: P consumers pay:
$ /unit $ /unit
P producers receive: P producers receive:
$ /unit $ /unit
Government receives: Government receives:
$ /unit $ /unit
 SMU Classification: Restricted

$3 Tax on Consumers
Tax on Consumers
Before Tax After Tax
P consumers pay: P consumers pay:
$ /unit $ /unit
P producers receive: P producers receive:
$ /unit $ /unit
Government receives: Government receives:
$ /unit $ /unit
 SMU Classification: Restricted

Key Ideas for Lecture 13

• Consumer surplus (CS) for an individual consumer is the difference

between the consumer’s willingness to pay for a product and the cost of
purchasing the product
• Producer surplus (PS) is the difference between the amount producers
actually receive by producing and selling a certain units and the amount
producers have to receive to produce a certain units
• There are three different degrees of price discrimination
• In progressive tax system, average and marginal tax rates are higher for
higher income levels

COR2100 39
Part 3
Final Review

40
 SMU Classification: Restricted

Final Exam

• 22 Nov 8:30 am-10:30 am

• Format (Closed book)
• 10 MCQ + 10 Short answer+4 Structured questions
• Comprehensive
• Macro part accounts for about 25%
• Bring
• Student ID, pens, pencils, rulers and erasers
• Non-programmable calculator
• laptop (Lock-Down Browser)
• A4 size handwritten cheat sheet COR2100 41
 SMU Classification: Restricted

Logistics

• Consultation
• 9 am – 10 am, Tue 16 Nov
• 9 am – 10 am, Wed 17 Nov
• 10 am – 11 am , Thur 18 Nov
• 9 am – 10 am, Friday 19 Nov
• I will not answer emails after 5:00 pm on 21 Nov
• beihong@smu.edu.sg
• https://smu-sg.zoom.us/j/9106197594?pwd=N0hHRkpEdjdtc2Y2QjBIZ2dOb3BRUT09
• Meeting ID: 910 619 7594
• Passcode: Hailey COR2100 42
 SMU Classification: Restricted

The Big Picture

Demand

Market
Equilibrium

Supply
COR2100 43
 SMU Classification: Restricted

Consumer Theory Road Map

• Consumption Possibilities 1. What do you like?

• Budget line
• Prices and income 2. How much does it
cost?
• Preference: Describe what consumers like?
3. How much money
• Consumer Choice do you have?
• How do consumers choose what to buy and how much
to buy?
• Best affordable choice
COR2100 44
 SMU Classification: Restricted

Theory of Firms Road Map

• How to produce at minimum cost

• Firm’s profit-maximizing output decision

• Construct individual firm’s supply curve

• How does the profit-maximizing output level changes with P ?

• Construct market supply curve

COR2100 45
 SMU Classification: Restricted

Question 1:Budget Line (Self practice)

• Suppose there are two goods. If the prices of both goods double and
the consumer’s income triples, then
• A. The slope of the budget line does not change but the budget line
shifts to the right
• B. The slope of the budget line does not change but the budget line
shifts to the left
• C. The slope of the budget line changes, and the budget line shifts to the
left
• D. The slope of the budget line changes, and the budget line shifts to
the right
COR2100 46
 SMU Classification: Restricted

Review Question 2 (Self practice)

Quantity (units) Shoes ($20/pair) Jeans ($10/pair)
  Marginal Benefits ($) Marginal Benefits ($)
0 – –
1 40 35
2 33 33
3 28 22
4 23 15
5 20 10
6 15 7.5

• Income= $150 per month. Estimate the bundle that maximizes

benefits COR2100 47
 SMU Classification: Restricted

Review Question 3 (Self practice)

• David charges the restaurant Flaming David’s $1,000 annually for use of
his name. If David increases the fee to use of his name, _______.
A the restaurant’s average fixed cost, average variable cost, average
total cost, and marginal cost curves all shift upwards.
B only the restaurant’s average fixed cost, average total cost, and
marginal cost curves shift upwards.
C only the restaurant’s average variable cost, average total cost, and
marginal cost curves shift upwards.
D only the restaurant’s average fixed cost and average total cost curves
shift upwards.
COR2100 48
 SMU Classification: Restricted

Review Question 4 (Self practice)

• If marginal product falls as an additional worker is employed,

then we know that average product ______.
A is less than marginal product
B exceeds marginal product
C falls if it is less than marginal product or rises if it exceeds
marginal product
D is less than marginal product and rising or more than marginal
product and falling
COR2100 49
 SMU Classification: Restricted

Review Question 5 (Self practice)

• A firm in a perfectly competitive market is producing the quantity

of the good at which marginal cost exceeds the market price.

This firm will increase its profit by producing _________.

A less of the good and not change the market price of the good
B less of the good and lower the market price of the good
C a larger quantity of the good
D the same quantity and raising its price of the good
COR2100 50
 SMU Classification: Restricted

Review Question 6 (Self practice)

• Suppose the book-printing industry is a perfect

competitive market and begins in a long run equilibrium
• If there is a new technology becomes available that
lowers cost of printing books
• What happens in the short run?
• What happens in the long run?

COR2100 51