DEPARTMENT OF ECONOMICS

ECON1000: Principles of Economics

Problem Set 3: The Market Model

1. How would each of the following occurrences likely affect the market diagram for ganja?
(that is, which curve will shift and in what direction?)
a) A rise in violent crime distracts police from interdicting ganja trafficking.
With a reduced fear of arrest amongst growers and traffickers, they are more willing provide
ganja, so the supply curve shifts to the right.
b) A rise in violent crime distracts police from arresting ganja smokers.
With a reduced fear of arrest amongst users, the demand curve shifts to the right.
c) A new study reveals that ganja use is promotes heart disease.
Discovery of the harmful effect of smoking ganja will discourage some smokers, shifting the
demand curve to the left.
d) The price of farming equipment rises.
Since the cost of inputs rise, the supply curve shifts to the left.
e) The frequency of hurricanes increase.
Frequent hurricanes will increase the likelihood of crop losses, which makes it more costly be a
ganja grower, so the supply curve shifts to the left.
f) The government imposes a higher tax on alcoholic drinks.
It’s possible that drinkers will seek alternative ways to feel high, which may increase the
willingness to buy ganja, shifting the demand curve for ganja to the right.
g) The price of Jamaican ginger on the world market rises.
Since growing ginger and growing ganja are alternative uses for agricultural land, a rise in the
price of ginger on world markets will motivate farmers to want to increase the cultivation of
ginger, which may take land away from the cultivation of ganja. So the ganja supply curve shifts
to the left.

2. What will happen to the equilibrium price and quantity of

a) oranges, if the wages paid to orange pickers rise? P
When the cost of an input into production rises, oranges become D S
more expensive to produce, which shifts the supply curve to the
left. The new market equilibrium (where the demand and supply
curves cross) is at a higher price and a lower quantity.

Q
b) fish, if fish oil is found to delay the onset of dementia in old age?
Since fish are found to have a new advantage, it will be more P
D S
desirous than before. This is represented as a shift of the demand
curve outward, that is, to the right. At the new equilibrium, the
price is higher and the quantity traded is greater.

Q
 c) taxi trips, if police were to enforce having proper documentation (registration,
fitness certification, and insurance) on vehicles used as taxis?
Insofar as many taxis on the road now are not compliant, having to P
D S
obtain proper documentation raise the cost of running a taxi,
making some drivers unwilling to run taxis at the fares. This is
equivalent to an inward (or upward shift) of the supply curve
which will result in a higher equilibrium price and lower
equilibrium quantity traded.

Q
d) beef, if the price of chicken falls?
A fall in the price of chicken will cause households to switch from P
D S
beef to chicken, reducing the demand for beef at any given price.
This is illustrated by an inward shift of the demand curve for beef.
As a result of that shift, both the price and quantity in the beef
market will fall.

3. What will happen to the equilibrium price and quantity of yam if an improved fertilizer
becomes available (at the same cost as the of old fertilizer)? Why don’t farmers charge
the same old price and make extra profits?
An improved fertilizer will raise the yield of yam growing, so P
D S
farmers will be able and willing to supply more at any given price.
This willingness is shown as an outward shift of the supply curve
for yams.
The excess supply of yams causes a fall in yam prices, so we end
up with a lower price and more yam being sold.
Market forces will force the price down. There is now more yam
on the market and consumers will not buy the extra yam at the old Q
price. The only way yam farmers will be able to sell the extra yam
is if they lower the price, which they will be willing to do because the cost of producing yam has
fallen with the improved fertilizer.

4. Use the market mechanism to explain why

a) the growth of China is the reason for the rise in world oil
P
prices. D S
As the Chinese economy grows, manufacturers in that country are
using ever greater amounts of energy, which is increasing the
demand for oil on the world market, shown as an outward shift of
the demand curve for oil. The potential excess demand is resolved
by a rise in the price of oil.

Q
 b) food prices rise after a tropical storm passes over Jamaica.
A tropical storm destroys agricultural crops creating a potential P
D S
shortage. The diagram shows the supply curve shifting to the left,
stimulating a rise in price to clear the market.

c) hotels on the North Coast offer discounted rates when

North America experiences a warmer than usual winter. Q

Warmer winters reduce the desire of North Americans to escape P

D S
from it, so tourist traffic to the tropics fall. Consequently, the
demand for hotel rooms in the Caribbean falls, as shown. The new
equilibrium price is lower, which is the equivalent of discounted
prices.

5. Imagine a series of wells tapping into a seemingly unlimited source of water. The only
cost of bringing the water to the surface is the energy to power the electric pump.
Illustrate this market in the market model. What do you expect to happen to the price of
water if there is increased public awareness of the health benefits of drinking water?
Since the water itself is free and the only cost of making the water P
D
available at the surface is the uniform cost of electricity, the supply
curve will be a flat line just covering the cost of electricity. This
reflects the situation in which producing a larger quantity of water S
would require a higher price.
In this case, a rise in demand would not result in a higher price
since the producers of water do not have higher costs for a larger
volume that have to be compensated for, as shown in the diagram.
Q

6. At an art market, held in a park every Artist Res. Buyer Subj.

Price Value
Saturday morning, sketch artists set up
Simpson $16,000 Perkins $70,000
their easels and wait for customers
Wilson $25,000 Wilkins $15,000
who want to have their portraits done. Tomkins $25,000
Watson $32,000
Each artist can do only one portrait Johnson $10,000 Jenkins $22,000
each market day, but because the artists are not Lawson $12,000 Atkins $95,000
equally skilled, the work is more difficult for Hudson $29,000 Harkins $45,000
some and so each has a different reservation
price – the price that barely makes it worth the effort to do the drawing and below
which he or she is not willing to do the work. The reservation prices of the artists and
the willingness-to-pay of the customers on one particular day are shown in the table.
a) What is the equilibrium price in this market?
First, we need the demand and supply information. Rearrange Res. Subj.
Quantity Price Value
the information in the two tables in descending order of
subjective value for the buyers, to get the demand schedule, 1 $10,000 $95,000
and in ascending order of reservation price for the artists, to 2 $12,000 $70,000
get the supply schedule. 3 $16,000 $45,000
4 $25,000 $25,000
A price of $25,000 equates the quantities demanded and
5 $29,000 $22,000
supplied at 4.
6 $32,000 $15,000
b) Calculate the amounts of consumer surplus and producer surplus, and the total
welfare created by this market.
Consumer surplus = subjective value – market price. The Subj. Market Cons.
consumer surplus for each transaction is shown in the last Value Price Surplus
column to the right. Summing these values yields the total $95,000 $25,000 $70,000
consumer surplus: $70,000 + $45,000 + $20,000 = $135,000. $70,000 $25,000 $45,000
$45,000 $25,000 $20,000
$25,000 $25,000 0

Producer surplus = market price – reservation price. The Market Res. Prod.
producer surplus for each transaction is shown in the last Price Price Surplus
column to the right. Summing these values yields the total $25,000 $10,000 $15,000
producer surplus: $15,000 + $13,000 + $9,000 = $ $25,000 $12,000 $13,000
$25,000 $16,000 $9,000
Value created = consumer surplus + producer surplus =
$25,000 $25,000 0
$135,000 + $37,000.