Dr. Shishkin
ECON 2106
Assignment #8
Fall 2010
ANSWERS
Allocative Efficiency and Consumer Surplus
1. Explain the difference between production efficiency and allocative efficiency.
Answer: Production efficiency means that we are operating at a point on the production
possibilities frontier and so we cannot produce more of a good or service without
producing less of some other good or service. Production efficiency occurs at all points
on the PPF. At any point inside the frontier, production is inefficient because we have
unemployed resources.
Allocative efficiency takes one’s preferences into account. When one achieved allocative
efficiency that person can not do any better than this because if he would try to produce
more of one good and less of another good, he will lose more that he would gain in terms
of his benefit. This is why that person should stay where MB=MC (see The Most
Important Diagram).
2. Explain why does the marginal benefit curve have a negative slope.
Answer: Each successive increase in the consumption of any good provides a lower level
of satisfaction, or benefit, than the preceding unit of consumption. For a specific
example, think of drinking water on a hot day. What is the first glass worth? How about
the second and third? The marginal benefit is the benefit from each additional glass of
water and, as the example indicates, the marginal benefit decreases as the amount of the
good increases.
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Dr. Shishkin
ECON 2106
Fall 2010
3. Based on the marginal analysis approach, when less than the efficient amount of a
good is produced, how does the marginal benefit of the last unit produced compare to its
marginal cost?
Answer: When less than the efficient amount of a good is produced, the marginal benefit
of the last unit produced exceeds its marginal cost. The fact that the marginal benefit
exceeds the marginal cost indicates that producing additional units of the good will move
the amount of production closer to the efficient quantity.
4. At the current production point on a nation’s production possibilities frontier, the
marginal benefit of a slice of pizza is 500 tacos while the marginal cost of producing a
slice of pizza is 750 tacos. For the nation to produce at the point of allocative efficiency,
what should be done?
Answer: The marginal benefit of a slice of pizza is less than its marginal cost. Therefore
to produce at the point of allocative efficiency, less pizza and hence more tacos should be
produced.
5. Jason needs help getting ready for the next test in his economics course and would like
to hire Maria, an economics tutor to help him. Jason is willing to pay $30 for the first
hour of tutoring, $25 for the second, $20 for the third, $15 for the fourth, and $10 for the
fifth. Maria charges $12 per hour for tutoring. For how many hours of tutoring will Jason
hire Maria? Why this amount of hours? What is Jason’s consumer surplus from the
tutoring?
Answer: Jason will hire Maria for 4 hours of tutoring. At $12 per hour, the marginal
benefit to Jason of the first, second, third, and fourth hour exceeds the price. But the
marginal benefit from the fifth hour is less than the price and so Jason will not hire Maria
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2
Dr. Shishkin
ECON 2106
Fall 2010
for the fifth hour. Jason’s total consumer surplus is $42, the sum of $18 from the first
hour plus $13 from the second plus $8 from the third plus $3 from the fourth.
6. The figure above shows Cindy’s demand for CDs per year.
a. What is Cindy's consumer surplus on all the CDs consumed if the price of a CD is
$12?
Answer: Her consumer surplus when the price of a CD is $12 equals $15, the area of the
triangle under the demand curve and above the price.
b. What is Cindy's consumer surplus on all the CDs consumed if the price of a CD is $9?
Answer: Her consumer surplus when the price of a CD is $9 equals $60, the area of the
triangle under the demand curve and above the price
c. What happens to Cindy's consumer surplus when the price of a CD falls? Does it
increase or decrease? By how much?
Answer: As the price of a CD falls, Cindy's consumer surplus increases by $45. This
result reflects the observation that consumers are better off when prices are lower.
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