Review questions

1. Suppose that there are 10 million workers in Canada and that each of these workers can
produce either 2 cars or 30 bushels of wheat in a year.

The opportunity cost of producing a car in Canada is 15 bushels of wheat

The opportunity cost of producing a bushel of wheat in Canada is 1/15 of a car

If Canada chooses to consume 10 million cars, the amount of wheat can it consume without
trade is 150 million bushels

Canada’s production possibilities frontier is:

Now suppose that the United States offers to buy 10 million cars from Canada in exchange for
20 bushels of wheat per car. If Canada continues to consume 10 million cars, the amount of
wheat this deal allows Canada to consume is 200 million bushels of wheat

Canada should …………………… (accept/ reject) the deal.

2. Suppose that the price of basketball tickets at your college is determined by market forces.
Currently, the demand and supply schedules are as follows:
The demand and supply curves:

The supply curve is …………………. (vertical/ horizontal). The constant quantity supplied makes
sense because the basketball arena has a……………… (fixed/ variable) number of seats at any
price.

Quantity supplied equals quantity demanded at a price of $8. The equilibrium quantity is 8,000
tickets.

Your college plans to increase total enrollment next year by 5,000 students. The additional
students will have the following demand schedule:

The new quantity demand is:

Price Quantity Demanded Quantity Supplied

$4 14,000 8,000

$8 11,000 8,000

$12 8,000 8,000

$16 5,000 8,000

The new equilibrium price will be $12 which equates quantity demanded to quantity supplied.
The equilibrium quantity remains 8,000 tickets.

3. Suppose that your demand schedule for pizza is as follows:

Using the midpoint method to calculate, the price elasticity of demand as the price of pizza
increases

from $8 to $10 if your income is $20,000 is [(40 – 32)/36]/[(10 – 8)/9] =0.22/0.22 = 1 and
your income is $24,000 is [(50 – 45)/47.5]/[(10 – 8)/9] = 0.11/0.22 = 0.5

Your income elasticity of demand as your income increases from $20,000 to $24,000 if the price
is $12 is [(30 – 24)/27]/[(24,000 – 20,000)/22,000] = 0.22/0.18 = 1.22 and the price is $16
is [(12 – 8)/10]/[(24,000 – 20,000)/22,000] = 0.40/0.18 = 2.22

4. Congress and the president decide that the United States should reduce air pollution by
reducing its use of gasoline. They impose a $0.50 tax on each gallon of gasoline sold.

It ……………………. (does/does not) matter whether the tax is imposed on producers or

With no tax, as shown in Figure, the demand curve is D1 and the supply curve is S1. If the tax is
imposed on producers, the supply curve shifts left by the amount of the tax (50 cents) to S2.
Then the equilibrium quantity is Q2, the price paid by consumers is P2, and the price received
(after taxes are paid) by producers is P2 – 50 cents. If the tax is instead imposed on consumers,
the demand curve shifts left by the amount of the tax (50 cents) to D2. The leftward shift in the
demand curve (when the tax is imposed on consumers) is exactly the same magnitude as the
leftward shift in the supply curve when the tax is imposed on producers. So again, the
equilibrium quantity is Q2, the price paid by consumers is P2 (including the tax paid to the
government), and the price received by producers is P2 – 50 cents. D2

If the demand for gasoline were more elastic, the more ……………. (effective, ineffective) this tax
will be in reducing the quantity of gasoline consumed. Greater elasticity of demand means that
quantity falls more in response to the rise in the price. Demand curve D1 represents an elastic
demand curve, while demand curve D2 is more inelastic. The tax will cause a greater decline in
the quantity sold when demand is elastic.

The consumers of gasoline are hurt by the tax because they get ……………..(less, more) gasoline
at a ………………….. (lower/higher) price.
Workers in the oil industry are hurt by the tax as well. With a lower quantity of gasoline being
produced, some workers may lose their jobs. With a lower price received by producers, wages
of workers might decline

5. The cost of producing flat-screen TVs has fallen over the past decade. Let’s consider some
implications of this fact.

The effect of falling production costs in the market for flat-screen TVs results in a shift to the
right in the supply curve, as shown in Figure. As a result, the equilibrium price of flat-screen
TVs declines and the equilibrium quantity increases.

The decline in the price of flat-screen TVs increases consumer surplus from area A to A + B + C
+ D, an increase in the amount B + C + D. Prior to the shift in supply, producer surplus was areas
B + E (the area above the supply curve and below the price). After the shift in supply, producer
surplus is areas E + F + G. So producer surplus changes by the amount F + G – B, which may be
positive or negative. The increase in quantity increases producer surplus, while the decline in
the price reduces producer surplus. Because consumer surplus rises by B + C + D and producer
surplus rises by F + G – B, total surplus rises by C + D + F + G.

If the supply of flat-screen TVs is very elastic, then the shift of the supply curve benefits
consumers most. To take the most dramatic case, suppose the supply curve were horizontal, as
shown in Figure. Then there is no producer surplus at all. Consumers capture all the benefits of
falling production costs, with consumer surplus rising from area A to area A + B
6. Consider the market for rubber bands.

With very elastic supply and very inelastic demand, the burden of the tax on rubber bands will
be borne largely by buyers. As Figure shows, consumer surplus declines considerably, by area
A + B, but producer surplus decreases only by area C+D.

With very inelastic supply and very elastic demand, the burden of the tax on rubber bands will
be borne largely by sellers. As Figure shows, consumer surplus does not decline much, just by
area A + B, while producer surplus falls substantially, by area C + D. Compared to part (a),
producers bear much more of the burden of the tax, and consumers bear much less.
7. The world price of wine is below the price that would prevail in Canada in the absence of
trade.

Assuming that Canadian imports of wine are a small part of total world wine production, Figure
illustrates the Canadian market for wine, where the world price of wine is P 1.

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. The shift in the Gulf Stream destroys some
of the grape harvest in Europe and raises the world price of wine to P2

P1 P2 CHANGE

Consumer Surplus A+B+D+E A+D –B - E

Producer Surplus C B+C +B

Total Surplus A+B+C+D+E A+B+C+D –E