The marginal value schedule for Moe and the marginal cost schedule for Larry for
ID: 1168111 • Letter: T
Question
The marginal value schedule for Moe and the marginal cost schedule for Larry for apples are shown below.
No. of Apples Moe's MV Larry's MC
1 $10 $1
2 7 2
3 5 4
4 3 5
(a) Find a single price that all mutually preferred trades can occur.
(b) What are the gains from trade?
(c) Now suppose a $1.50 per-unit tax is levied on Larry for each unit sold (that raises MC by $1.50). Now find all mutually preferred trades and the trading prices. Is the demander harmed by a tax levied on the supplier? Explain.
Explanation / Answer
Answer)
A) Mutually beneficial trade occurs where Marginal Value equals Marginal cost. In this case they are never perfectly equal, but this occurs at a quantity of 3 apples. Thus, Price = MC =MV. The consumer buys apples as long as the marginal value of an apple exceeds its price and stops when the two become equal. In other words, he chooses that quantity at which price equals marginal value. Thus, Price = $5.
B) Gains from trade are measured by consumer surplus and producer surplus to both the parties. Alternatively, rather than separately computing a consumer’s surplus and a producer’s surplus, we can calculate the total welfare gain created by each apple. i.e, MV –MC for each unit. Thus, Gains = [$10 -$1] + [$7 - $2] + [$5 -$4] = $15.
C)
No. of Apples
Moe's MV
Larry's MC
Larry's After tax MC
1
$10
$1
$2.5
2
7
2
3.5
3
5
4
5.5
4
3
5
6.5
With a per unit increase in tax, mutually beneficial trade occurs where Marginal Value equals New Marginal cost. Thus, Price = MC =MV. The consumer buys apples as long as the marginal value of an apple exceeds its price and stops when the two become equal. In other words, he chooses that quantity at which price equals marginal value. But when Quantity = 3 units, Price = $5, MC exceeds price, hence Larry won’t sell at a price of $5. At other quantities MV is not equal to MC, hence there is no equilibrium, thus the demander is harmed with this tax.
No. of Apples
Moe's MV
Larry's MC
Larry's After tax MC
1
$10
$1
$2.5
2
7
2
3.5
3
5
4
5.5
4
3
5
6.5
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