CASE STUDIES IN MICROECONOMICS

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CASE STUDIES IN MICROECONOMICS

• Dr Paul Crompton
• School of Economics and Commerce
• University of Western Australia

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Consumer Surplus
The most common interpretation of a demand curve
is price determines quantity. That is, if the
price is 5 this consumer demands two units,
while if the price is 2 this consumer demands 10
units. However, the demand curve also shows us
the willingness to pay of a consumer. It is this
interpretation of a demand curve that is
essential for the concept of consumer surplus.
P
S
5
2
D
Q
10
2
3
Producer Surplus
A common error among students is thinking that
producer surplus equals profit for the firm.
P
S
2
D
Q
10
4
Housing Auctions
Assume there are three people bidding in an
auction for a house. They have maximum
willingness to pays of 750,000 and 720,000
and 700,000. These amounts are unknown during
the auction. What price will the house sell
for? How can we get as close to the
equilibrium price as possible?
P
S1
A, 750,000
B, 720,000
C, 700,000
D
Q
1
5
Perths Gas Shortage
Assume we are in equilibrium at point A. Then
there is a sudden decrease in supply. The
immediate problem is excess demand at the
existing price (A - C). Economic theory tells us
to simply raise the price and restore equilibrium
at point B. This presents a problem in that many
low income households will be priced out of the
market. If the price is kept at P1 to avoid this
then it poses an allocation problem, ie how to
allocate the available 70 units among the 100
households demanding gas (assuming that each
household demands one unit). The state
governments solution has been to appeal to
households to cut back consumption to eliminate
the shortage. However, some (most) households
will not change their consumption habits and rely
on others to do the right thing.
P
S1
S2
B
P2
A
P1
C
Setting the new equilibrium price of P2 leads to
the most efficient solution. That is, the people
who value the gas the most will receive it. In
this case, price is the allocation
mechanism. However, appealing to households to
cut back on consumption (if successful) is
perhaps a fairer solution. In this case we have a
non-price allocation mechanism.
D
Q
100
70
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Banana Prices
Why did banana prices increase so sharply?
P
S1
S2
18
B
15
A
2
D
Q