TUTORIAL EXERCISES

Question 1
The graph below represents the market for walnuts. Identify the values of the marginal benefit (MB) and
the marginal cost (MC) at the output levels of 2,000 pounds, 4,000 pounds and 6,000 pounds. At each of
these output levels, state whether output is inefficiently high, inefficiently low, or economically efficient.

2,000 pounds:
Marginal benefit = $3.50
Marginal cost = $2.50
Output level = inefficiently low

4,000 pounds:
Marginal benefit and Marginal cost = $3.00 (MB = MC)
Output level = economically efficient

6,000 pounds:
Marginal benefit = $2.50
Marginal cost = $3.50
Output level = inefficiently high

Question 2
Suppose that a frost in Florida reduces the size of the orange crop, which causes the supply curve for
oranges to shift to the left. Briefly explain whether consumer surplus will increase or decrease and
whether producer surplus will increase or decrease. Use a demand and supply graph to illustrate your
answers.

Before the supply curve shifted, the equilibrium point indicates P1 as equilibrium price and Q1 as
equilibrium quantity. Area ABCD is the consumer surplus and area EFG is the producer surplus. When
the supply curve leftward shifting from S1 to S2 which caused the price increased and quantity
decreased, therefore, consumer surplus decreased, and only area A remained as the consumer surplus.
When the price is higher than the initial equilibrium price, consumers will have to purchase at a higher
price, consumer’s marginal benefits will decrease, and fewer consumers will purchase the product
because what consumers value the product is not the same as what the seller value. The producer
surplus is unknown even if it changed from area EFG to BE. However, the area B is uncertain. If the area
B is greater than area F and G, the producer surplus increase, but if the area B is smaller than the area F
and G, the producer surplus decrease.

Question 3
Suppose that the government sets a price floor for milk that is above the competitive equilibrium price
and that the government does not purchase any surplus milk.
a. Draw a graph showing this situation. Be sure your graph shows the competitive equilibrium
price, the price floor, the quantity that would be sold in competitive and the quantity that
would be sold with the price floor.

b. Compare the economic surplus in this market when there is a price floor and when there is
not.

When there isn’t a price floor, the equilibrium point shows Pe as the equilibrium price and Q1 as the
equilibrium quantity, and marginal benefit is equal to marginal cost. The economic surplus will be
represented by the area of ABCDE. When the government impose price floor, the price increase above
equilibrium price and shown by the horizontal line of PF. The quantity demanded decreased and
quantity supply increase from Q1 to Q2. The economic surplus reduced from areas ABCDE to only area
ABD, causing a deadweight loss in area C and E.

Question 4
Suppose the current equilibrium price of a sandwich is $5, and 10 million sandwiches are sold per
month. After the federal government imposes a tax of $0.50 per sandwich, the equilibrium price of
sandwich rises to $5.20, and the equilibrium quantity falls to 9 million.
 a. Illustrate this situation with a well-labeled graph.

b. Indicate the area of consumer surplus and producer surplus after tax, the tax revenue collected
by the government and deadweight loss.

After government imposed the tax on the sandwich, the supply curve shifts to the left. The new
equilibrium point shows $5.20 as the equilibrium price and 9 million as the equilibrium quantity.
Consumer surplus represents the area that above the equilibrium price of $5.20 and below the demand
curve. The producer surplus shows below $4.70 and above the supply curve. Tax revenue will be the
triangle between the consumer surplus and producer surplus. The small triangle shows the area of
deadweight loss.

c. How much tax revenue does the government collect?

$5.20 - $4.70 = $0.50 (9 million) = $45,000

d. What is the value of excess burden/deadweight loss?

½ (base) (height) = ½ ($0.50) (10 million – 9 million) = 0.25 million

e. Is this sandwich tax efficient?

Yes. Tax is efficient if it imposed a small excess burden relative to the tax revenue to reduce the
consumption of product. The demand curve is elastic, therefore the tax imposed on product has a
significant impact.
Reason to impose tax: government able to collect revenue and reduce the consumption and production
of certain products

Media review analysis: Answer the questions based on the excerpt below.
 According to an article in New York Times, the Venezuelan government “imposes strict
price controls that are intended to make a range of foods and other goods more affordable
for the poor.”

Source: William Neuman, “With Venezuelan Cupboards Bare, Some Blame Price Controls,” New York Times,
April 20, 2012.

Explain and analyze graphically the economic effect of the price control introduced to the range of food
in Venezuela. Indicate on your graph the area representing consumer surplus, producer surplus and
deadweight loss.

Before the government imposed the price ceiling, the equilibrium point shows P* as the equilibrium
price and Q* as the equilibrium quantity. The consumer surplus is the area below demand curve and
above equilibrium price level, which represents the area ABC. The producer surplus represents the area
of DEF. After government imposed the price ceiling, the price level will reduce and lower than the initial
equilibrium price. The quantity supply will also decrease. Consumer surplus will increase from area ABC
to area ABD. The producer surplus will decrease from area DEF to only area F. This causes a deadweight
loss in area c and e. Shortage will happen in the market, which causes the black market exists and
occurrence of opportunity cost due to buyers spending on product searching activities.