Chapter 19: Problem 4

As the price of a service rises, (LO6) a) the consumer surplus decreases b) the consumer surplus increases c) the consumer surplus may increase or decrease

Short Answer

Expert verified

When the price of a service rises, the consumer surplus decreases, regardless of whether the demand curve is linear, inelastic, or elastic. This is because the area under the demand curve representing consumer surplus gets smaller as the price rises and the quantity demanded decreases. Thus, the correct answer is (a) the consumer surplus decreases.

Step by step solution

Introduction

First, let's understand the concept of consumer surplus. Consumer surplus is the difference between the amount consumers are willing and able to pay for a good or service and the amount they actually pay. In simple terms, it is the "extra satisfaction" consumers get when they are able to purchase goods or services at a price lower than their maximum willingness to pay. Now let's examine the effect of a price increase on consumer surplus.

Price increase and demand curve

In most cases, when the price of a product or service increases, the quantity demanded by consumers decreases. This is represented by a downward sloping demand curve. We can consider three scenarios to see how consumer surplus might change with different demand curve shapes: 1) Linear demand curve 2) Inelastic demand curve 3) Elastic demand curve

Linear demand curve

A linear demand curve is a straight line, with the quantity demanded decreasing at a constant rate as the price increases. With a linear demand curve, when the price of the service rises, the consumer surplus decreases. This is because the area under the demand curve that represents consumer surplus gets smaller as the price rises.

Inelastic demand curve

An inelastic demand curve is one where the price increase does not have a significant impact on the quantity demanded. This could occur in the case of essential goods or services, where consumers do not have much choice but to continue purchasing the product even at higher prices. With an inelastic demand curve, when the price of the service rises, the consumer surplus also decreases. This is because the area under the demand curve that represents consumer surplus is still getting smaller, even though the decrease in quantity demanded might not be as significant as in the case of a linear demand curve.

Elastic demand curve

An elastic demand curve is one where the price increase significantly affects the quantity demanded. This often occurs in the case of luxury goods or services or those with many close substitutes. When the price of the service rises, the consumer surplus also decreases. This is because the area under the demand curve representing consumer surplus is getting smaller as the quantity demanded drops sharply in response to the price increase.

Conclusion

Based on analyzing different demand curves, we can conclude that when the price of a service rises, regardless of whether the demand curve is linear, inelastic, or elastic, the consumer surplus decreases. Therefore, the correct answer is (a) the consumer surplus decreases.

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