Suppose Island Bikes, a profit-maximizing firm, is the only bike rental company

Question

Suppose Island Bikes, a profit-maximizing firm, is the only bike rental company in a small resort town. The marginal cost to Island Bikes of renting out a bike is $3, and Island Bikes has no fixed costs. Each day Island Bikes has six potential customers, whose reservations prices are listed below.

Suppose Island Bikes knows that customers whose reservation prices are at least $10 always rent bikes before noon, while those whose reservation prices are below $10 never do so. If Island Bikes charges a different price in the morning and in the afternoon, then what will be the total economic surplus?

A) $49

B) $41

C) $3

D) $9

Explanation / Answer

Given the information that customers whose reservation prices are at least $10 always rent bikes before noon, while those whose reservation prices are below $10 never do so, it is profitable to charge minimum reservation prices from first group (A, B, C) and a price of $6 from second group (C, D, E).

Profit /producer surplus = 12 x 3 - 3 x 3 = 27 (First group) + 6 x 2 - 3 x 2 = $6 (Second group) = $33.

Consumer surplus = (22 + 16 + 12 - 12 x 3) + (8 + 6 - 6 x 2) = 16

Total surplus = 16 + 33 = 49.

Correct answer is $49.  

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