Question

[10 points] Suppose Wilwaukee Telecom offers its users the option of paying either (a) $2.00 per minute for telephone service or (b) a $125 flat charge for a year of unlimited toll-free calls. Consider a customer with an annual demand for telephone service of P = 11 – 0.1Q, where P is the price per minute and Q is the number of minutes of calls made per year. Calculate the consumer surplus for each of the plans (a) and (b).

Answer 1

For plan A, P = 2.

Then from demand curve, 2 = 11-.1Q

So .1Q = 9

Q* = 90

B) under plan b, P = zero

So make 11 = .1Q

Q* = 110

Now Consumer surplus from a)

CS = .5*(11-2)*90 = ∆ABC

= .5*9*90 = 405

From b)

CS = .5*11*110 - 125 = ∆ ADE - fixed fee

= 605-125 = 480