The government has decided that the free-market price of cheese is too low. A. Suppose the government imposes a binding price floor in the cheese market. Draw a supply-and-demand diagram to show the effect of this policy on the price of cheese and the quantity of cheese sold. Is there a shortage or surplus of cheese? B. Producers of cheese complain that the price floor has reduced their total revenue. Is this possible? Explain. C. In response to cheese producers’ complaints, the government agrees to purchase all the surplus cheese at the price floor.
Compared to the basic price lour, who benefits from this new policy? Who loses? Answer a. The imposition of a binding price floor in the cheese market is shown in Figure below. In the absence of the price floor, the price would be Pl and the quantity would be IQ. With the floor set at If, which is greater than Pl, the quantity demanded is Q, while quantity supplied is Q, so there is a surplus of cheese in the amount Q – Q. B. The farmers’ complaint that their total revenue has declined is correct if demand is elastic.
With elastic demand, the percentage decline in quantity would exceed the percentage rise in price, so total revenue would decline. . If the government purchases all the surplus cheese at the price floor, producers benefit and taxpayers lose. Producers would produce quantity Q of cheese, and their total revenue would increase substantially. However, consumers would buy only quantity Q of cheese, so they are in the same position as before. Taxpayers lose because they would be financing the purchase of the surplus cheese through higher taxes.
QUESTION 4 Suppose the federal government requires beer drinkers to pay a $2 tax on each case of beer purchased. (In fact, both the federal and state governments impose beer taxes of some sort. A. Draw a supply-and-demand diagram of the market for beer without the tax. Show the price paid by consumers, the price received by producers, and the quantity of beer sold. What is the difference between the price paid by consumers and the price received by producers? B. B. Now draw a supply-and-demand diagram for the beer market with the consumers and the price received by producers? Has the quantity of beer sold increased or decreased? . A) Figure below shows the market for beer without the tax. The equilibrium price is Pl and the equilibrium quantity is IQ . The price paid by consumers is the same s the price received by producers. B) When the tax is imposed, it drives a wedge of $2 between supply and demand, as shown in Figure below. The price paid by consumers is UP, while the price received by producers is UP- $2. The quantity of beer sold declines to Q. QUESTION 8 A case study in this chapter discusses the federal minimum-wage law. A) Suppose the minimum wage is above the equilibrium wage in the market for unskilled labor.
Using a supply-and-demand diagram of the market for unskilled labor, show the market wage, the number of workers who are employed, and the number of workers who are unemployed. Also show the total wage payments to unskilled workers. B) Now suppose the secretary of labor proposes an increase in the minimum wage. What effect would this increase have on employment? Does the change in employment depend on the elasticity of demand, the elasticity of supply, both elasticity, or neither? C) What effect would this increase in the minimum wage have on unemployment?
Does the change in unemployment depend on the elasticity of demand, the elasticity of supply, both elasticity, or neither? Answer a) Figure below shows the effects of the minimum wage. In the absence of he minimum wage, the market wage would be WI and IQ workers would be employed. With the minimum wage (whom) imposed above WI, the market wage is whom, the number of employed workers is Q, and the number of workers who are unemployed is Q – Q. Total wage payments to workers are shown as the area of rectangle ABACA, which equals whom times Q. B) An increase in the minimum wage would decrease employment.
The size of the effect on employment depends only on the elasticity of demand. The elasticity of supply does not matter, because there is a surplus of labor. C) The increase in the minimum wage would increase unemployment. The size f the rise in unemployment depends on both the elasticity of supply and demand. The elasticity of demand determines the change in the quantity of labor demanded, the elasticity of supply determines the change in the quantity of labor supplied, and the difference between the quantities supplied and demanded of labor is the amount of unemployment. ) If the demand for unskilled labor were inelastic, the rise in the minimum wage would increase total wage payments to unskilled labor. With inelastic demand, the percentage decline in employment would be lower than the percentage increase in the wage, so total wage payments increase. However, if the demand for unskilled labor were elastic, total wage payments would decline, because then the percentage decline in employment would exceed the percentage increase in the wage. Chapter 7, Problems & Applications: 1, 4, 5, 6 QUESTION 1 Melissa buys an phone for $120 and gets consumer surplus of $80. ) What is her willingness to pay? B) If she had bought the phone on sale for $90, what would her consumer surplus have been? C) If the price of an phone were $250, what would her consumer surplus have been? Question 4 It is a hot day, and Bert is thirsty. Here is the value he places on each bottle of eater: Value of first bottle $7 Value of second bottle $5 Value of third bottle $3 Value of fourth bottle $1 a) From this information, derive Beret’s demand schedule. Graph his demand curve for bottled water. B) If the price of a bottle of water is $4, how many bottles does Bert buy?
How much consumer surplus does Bert get from his purchases? Show Beret’s consumer surplus in your graph. C) If the price falls to $2, how does quantity demanded change? How does Beret’s consumer surplus change? Show these changes in your graph. A) Beret’s demand schedule is: Price Quantity Demanded More than $7 $5 to $7 $3 to $5 $1 to $3 $1 or less 2 3 Beret’s demand curve is shown in Figure below: b) When the price of a bottle of water is $4, Bert buys two bottles of water. His consumer surplus is shown as area A in the figure. He values his first bottle of water at $7, but pays only $4 for it, so has consumer surplus of $3.
He values his second bottle of water at $5, but pays only $4 for it, so has consumer Surplus of $1. Thus Beret’s total consumer surplus is $3 + $1 = $4, which is the area of A in the figure. C) When the price of a bottle of water falls from $4 to $2, Bert buys three bottles of water, an increase of one. His consumer surplus consists of both areas A and B in the figure, an increase in the amount of area B. He gets consumer surplus of $5 from the first bottle ($7 value minus $2 price), $3 from the second bottle ($5 value minus $2 price), and $1 from the third bottle ($3 value minus $2 price), for a total consumer surplus of $9.
Thus consumer surplus rises by $5 (which is the size of area B) when the price of a bottle of water falls from $4 to $2. M QUESTION 5 Ernie owns a water pump. Because pumping large amounts of water is harder than pumping small amounts, the cost of producing a bottle of water rises as he pumps more. Here is the cost he incurs to produce each bottle of water: Cost of iris bottle $1 Cost of second bottle $3 Cost of third bottle $5 Cost of fourth bottle $7 a) From this information, derive Ermine’s supply schedule. Graph his supply curve for bottled water. ) If the price of a bottle of water is $4, how many bottles does Ernie produce and sell? How much producer surplus does Ernie get from these sales? Show Ermine’s producer surplus in your graph. C) If the price rises to $6, how does quantity supplied change? How does Ermine’s producer surplus change? Show these changes in your graph. Answer a) Ermine’s supply schedule for water is: Price Quantity Supplied More than $7: $5 to $7: $3 to $5: $1 to $3: Less than $1: b) When the price of a bottle of water is $4, Ernie sells two bottles of water.
His producer surplus is shown as area A in the figure. He receives $4 for his first bottle of water, but it costs only $1 to produce, so Ernie has producer surplus of $3. He also receives $4 for his second bottle of water, which costs $3 to produce, so he has producer surplus of $1 . Thus Ermine’s total producer surplus is $3 + $1 ? $4, which is the area of A in the figure. C) When the price of a bottle of water rises from $4 to $6, Ernie sells three bottles of water, an increase of one. His producer surplus consists of both areas A and B n the figure, an increase by the amount of area B.
He gets producer surplus of $5 from the first bottle ($6 price minus $1 cost), $3 from the second bottle ($6 price minus $3 cost), and $1 from the third bottle ($6 price minus $5 price), for a total producer surplus of $9. Thus producer surplus rises by $5 (which is the size of area B) when the price off bottle of water rises from $4 to $6. Question 6 Consider a market in which Bert from problem 4 is the buyer and Ernie from problem 5 is the seller. A) Use Ermine’s supply schedule and Beret’s demand schedule to find the quantity supplied and quantity demanded at prices of $2, 4, and $6.
Which of these prices brings supply and demand into equilibrium? B) What are consumer surplus, producer surplus, and total surplus in this equilibrium? C) If Ernie produced and Bert consumed one fewer bottle of water, what would happen to total surplus? D) If Ernie produced and Bert consumed one additional bottle of water, what would happen to total surplus? Answer a) From Ermine’s supply schedule and Beret’s demand schedule, the quantity demanded and supplied are: Price Quantity Supplied Quantity Demanded $6 Only a price of $4 brings supply and demand into equilibrium, with an equilibrium quantity of two. At a price of $4, consumer surplus is $4 and producer surplus is $4, as shown in Problems 3 and 4 above. Total surplus is $4 + $4 = $8. C) If Ernie produced one less bottle, his producer surplus would decline to $3, as shown in Problem 4 above. If Bert consumed one less bottle, his consumer surplus would decline to $3, as shown in Problem 3 above. So total surplus would decline to $3 + $3 = $6. D) If Ernie produced one additional bottle of water, his cost would be $5, but the price is only $4, so his producer surplus would decline by $1 .
If Bert consumed one additional bottle of water, his value would be $3, but the price is $4, so his nonuser surplus would decline by $1 . So total surplus declines by $1 + $1 = $2. Chapter 8, Question for Review: 1 & 2 What happens to consumer and producer surplus when the sale of a good is taxed? How does the change in consumer and producer surplus compare to the tax revenue? Explain. Answer When the sale of a good is taxed, both consumer surplus and producer surplus decline. The decline in consumer surplus and producer surplus exceeds the amount of government revenue that is raised, so society’s total surplus declines.
The tax distorts the incentives of both buyers and sellers, so resources are allocated inefficiently. Draw a supply-and-demand diagram with a tax on the sale of a good. Show the deadweight loss. Show the tax revenue. Answer Figure below illustrates the deadweight loss and tax revenue from a tax on the sale of a good. Without a tax, the equilibrium quantity would be IQ, the equilibrium price would be P 1, consumer surplus would be A + B + C, and producer surplus would be D + E + F. The imposition of a tax places a wedge between the price buyers pay, BP, and the price sellers receive, AS, where BP = AS+ tax.
The quantity sold declines to Q. Now consumer SUrplUS is A, producer surplus is F, and government revenue is B + D. The deadweight loss of the tax is C+E, because that area is lost due to the decline in quantity from IQ to Q. Chapter 10, Problems & Applications: 4 & 5 Greater consumption of alcohol leads to more motor vehicle accidents and, thus, imposes costs on people who do not drink and drive. A) Illustrate the market for alcohol, labeling the demand curve, the social-value curve, the supply curve, the social-cost curve, the market equilibrium level of output, and the efficient level of output. ) On your graph, shade the area corresponding to the deadweight loss of the market equilibrium. (Hint: The deadweight loss occurs because some nits of alcohol are consumed for which the social cost exceeds the social value. ) Explain. A) The market for alcohol is shown in Figure below. The social value curve is below the demand curve because of the negative externalities from increased motor vehicle accidents caused by those who drink and drive. The free-market equilibrium level of output is Smarter and the efficient level of output is Captious. ) The triangular area between points A, B, and C represents the deadweight loss of the market equilibrium. This area shows the amount by which social costs exceed social value for the quantity of alcohol consumption beyond the efficient bevel. Many observers believe that the levels of pollution in our society are too high. A) If society wishes to reduce overall pollution by a certain amount, why is it efficient to have different amounts of reduction at different firms? B) Command-and-control approaches often rely on uniform reductions among firms.
Why are these approaches generally unable to target the firms that should undertake bigger reductions? C) Economists argue that appropriate corrective taxes or treatable pollution rights will result in efficient pollution reduction. How do these approaches target the firms that should undertake bigger reductions? ) It is efficient to have different amounts of pollution reduction at different firms because the costs of reducing pollution differ across firms. If they were all made to reduce pollution by the same amount, the costs would be low at some firms and prohibitive at others, imposing a greater burden overall. ) Command-and-control approaches that rely on uniform pollution reduction among firms give the firms no incentive to reduce pollution beyond the mandated amount. Instead, every firm will reduce pollution by just the amount required and no more. C) Corrective taxes or treatable pollution rights give firms greater incentives to educe pollution. Firms are rewarded by paying lower taxes or spending less on permits if they find methods to reduce pollution, so they have the incentive to engage in research on pollution control.
The government does not have to figure out which firms can reduce pollution the most At lets the market give firms the incentive to reduce pollution on their own. Chapter 1 1, Problems and Applications: 1, 4 Think about the goods and services provided by your local government. A) Using the classification in Figure 1, explain which category each of the following goods falls into: police protection snow plowing education rural roads city streets b) Why do you think the government provides items that are not public goods? A.
Category are given below: Police protection is a natural monopoly, because it is clubbable (the police may ignore some neighborhoods) and not rival in consumption. You could make an argument that police protection is rival in consumption, if the police are too busy to respond to all crimes, so that one person’s use of the police reduces the amount available for others. In that case, police protection is a private good. Snow plowing is most likely a common resource. Once a street is plowed, it is not clubbable. But it is rival in consumption, especially right after a big snowfall, because plowing one street means not plowing another street.
Education is a private good (with a positive externalities). It is clubbable, because someone who does not pay can be prevented from taking classes. It is rival in consumption, because the presence of an additional student in a class reduces the benefits to others. Rural roads are public goods. They are not clubbable and they are not rival in consumption because they are uncontested. City streets are common resources when congested. They are not clubbable, because anyone can drive on them. But they are rival in consumption, because congestion means that every additional driver slows down the progress of other drivers.
When they are not congested, city streets are public goods, because they are no longer rival in consumption. B. The government may provide goods that are not public goods, such as education, because of the externalities associated with them. Wireless, high-speed Internet is provided for free in the airport of the city of Communicatively. A) At first, only a few people use the service. What type of a good is this and why? ) Eventually, as more people find out about the service and start using it, the speed of the connection begins to fall. Now what type of a good is the wireless Internet service? ) What problem might result and why? What is one possible way to correct this problem? Chapter 9, Problems : 1, 2, 3 The world price of wine is below the price that would prevail in Canada in the absence of trade. A) Assuming that Canadian imports of wine are a small part of total world wine production, draw a graph for the Canadian market for wine under free trade. Identify consumer surplus, producer surplus, and total surplus in an appropriate able. B) Now suppose that an unusual shift of the Gulf Stream leads to an unseasonably cold summer in Europe, destroying much of the grape harvest there.
What effect does this shock have on the world price of wine? Using your graph and table from part (a), show the effect on consumer surplus, producer surplus, and total surplus in Canada. Who are the winners and losers? Is Canada as a whole better or worse off? A) Figure illustrates the Canadian market for wine, where the world price of wine The following table illustrates the results under the heading ” Pl. ” b) The shift in the Gulf Stream destroys some of the grape harvest in Europe and asses the world price of wine to UP.
The table shows the new areas of consumer, producer, and total surplus, as well as the changes in these Surplus measures. Consumers lose, producers win, and Canada as a whole is worse off. QUESTION Suppose that Congress imposes a tariff on imported autos to protect the U. S. Auto industry from foreign competition. Assuming that the United States is a price taker in the world auto market, show the following on a diagram: the change in the quantity of imports, the loss to U. S. Consumers, the gain to U. S. Manufacturers, government revenue, and the deadweight loss associated with he tariff.