Read and consider the “Willingness to Pay” example in Section 7-1 (Chapter 7 Section 1)
Everyone shops for things they need for themselves and for gifts for others. Imagine you are taking an online class and you are looking to buy a new computer because your old one died. Class starts in two days. The market for computers is very competitive. There are several brands that have similar characteristics such as storage capacity, processor speed, number of USB ports, etc. but you have owned one that you liked and you want to buy that same brand, the X-Mark.
You have a budget of $1,000. One popular store has the brand you like on sale for $850 because other stores are selling them for that price. You have a friend at that store who tells you that the store paid $700 for that computer.
Please evaluate and explain the willingness to pay, consumer surplus, demand, producer surplus, cost, and willingness to sell of this transaction. Define these terms in your explanation, not as separate definitions. Incorporate the meaning into your narrative so that you write a convincing story.
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Section 7-1 (Chapter 7 Section 1)
7-1aWillingness to Pay
Imagine that you own a mint-condition recording of Elvis Presley’s first album. Because you are not an Elvis Presley fan, you decide to sell it. One way to do so is to hold an auction.
Four Elvis fans show up for your auction: Taylor, Carrie, Rihanna, and Gaga. They would all like to own the album, but each of them has a limit on the amount she is willing to pay for it. Table 1 shows the maximum price that each of the four possible buyers would pay. A buyer’s maximum is called her willingness to pay, and it measures how much that buyer values the good. Each buyer would be eager to buy the album at a price less than her willingness to pay, and each would refuse to buy the album at a price greater than her willingness to pay. At a price equal to her willingness to pay, the buyer would be indifferent about buying the good: If the price is exactly the same as the value she places on the album, she would be equally happy buying it or keeping her money.
Table 1Four Possible Buyers’ Willingness to PayBuyerWillingness to PayTaylor$100Carrie80Rihanna70Gaga50
To sell your album, you begin the bidding process at a low price, say, . Because all four buyers are willing to pay much more, the price rises quickly. The bidding stops when Taylor bids (or slightly more). At this point, Carrie, Rihanna, and Gaga have all dropped out of the bidding because they are unwilling to offer any more than . Taylor pays you and gets the album. Note that the album has gone to the buyer who values it most.
What benefit does Taylor receive from buying the Elvis Presley album? In a sense, Taylor has found a real bargain: She is willing to pay for the album but pays only . We say that Taylor receives consumer surplus of . Consumer surplus is the amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it.
Consumer surplus measures the benefit buyers receive from participating in a market. In this example, Taylor receives a benefit from participating in the auction because she pays only for a good she values at . Carrie, Rihanna, and Gaga get no consumer surplus from participating in the auction because they left without the album and without paying anything.
Now consider a somewhat different example. Suppose that you had two identical Elvis Presley albums to sell. Again, you auction them off to the four possible buyers. To keep things simple, we assume that both albums are to be sold for the same price and that no one is interested in buying more than one album. Therefore, the price rises until two buyers are left.
In this case, the bidding stops when Taylor and Carrie bid (or slightly higher). At this price, Taylor and Carrie are each happy to buy an album, and Rihanna and Gaga are not willing to bid any higher. Taylor and Carrie each receive consumer surplus equal to her willingness to pay minus the price. Taylor’s consumer surplus is , and Carrie’s is . Taylor’s consumer surplus is higher now than in the previous example because she gets the same album but pays less for it. The total consumer surplus in the market is .
