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PS - Chapter 6

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9 views4 pages

PS - Chapter 6

Uploaded by

Ngoc Nhi Luu Nguyen
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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6 SUPPLY, DEMAND, AND

GOVERNMENT POLICIES

2. The government has decided that the freemarket 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. Farmers complain that the price floor has reduced their total revenue. Is this possible? Explain.

c. In response to farmers’ complaints, the government agrees to purchase all the surplus cheese at
the price floor. Compared to the basic price floor, who benefits from this new policy? Who loses?

Solution
2. a. The imposition of a binding price floor in the cheese market is shown in Figure 4.
In the absence of the price floor, the price would be P1 and the quantity would be
Q1. With the floor set at Pf, which is greater than P1, the quantity demanded is Q2,
while quantity supplied is Q3, so there is a surplus of cheese in the amount Q3 –
Q 2.
Figure 4

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.

c. If the government purchases all the surplus cheese at the price floor, producers
benefit and taxpayers lose. Producers would produce quantity Q3 of cheese, and
their total revenue would increase substantially. However, consumers would buy
only quantity Q2 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.

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. Now draw a supply-and-demand diagram for the beer market with 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? Has the quantity of beer
sold increased or decreased?

Solution
4. a. Figure 5 shows the market for beer without the tax. The equilibrium price is P1 and
the equilibrium quantity is Q1. The price paid by consumers is the same as the
price received by producers.

Figure 5 Figure 6
b. When the tax is imposed, it drives a wedge of $2 between supply and demand, as
shown in Figure 6. The price paid by consumers is P2, while the price received by
producers is
P2 – $2. The quantity of beer sold declines to Q2.

9. The U.S. government administers two programs that affect the market for cigarettes. Media
campaigns and labeling requirements are aimed at making the public aware of the dangers of
cigarette smoking. At the same time, the Department of Agriculture maintains a price-support
program for tobacco farmers, which raises the price of tobacco above the equilibrium price.

a. How do these two programs affect cigarette consumption? Use a graph of the cigarette market in
your answer.

b. What is the combined effect of these two programs on the price of cigarettes?

c. Cigarettes are also heavily taxed. What effect does this tax have on cigarette consumption?

Solution
9. a. Programs aimed at making the public aware of the dangers of smoking reduce the
demand for cigarettes, shown in Figure 10 as a shift from demand curve D1 to D2.
The price support program increases the price of tobacco, which is the main
ingredient in cigarettes. As a result, the supply of cigarettes shifts to the left, from
S1 to S2. The effect of both programs is to reduce the quantity of cigarette
consumption from Q1 to Q2.

Figure 10

b. The combined effect of the two programs on the price of cigarettes is ambiguous.
The education campaign reduces demand for cigarettes, which tends to reduce
the price. The tobacco price supports raising the cost of production of cigarettes,
which tends to increase the price. The end result on price depends on the relative
sizes of these two effects.
c. The taxation of cigarettes further reduces cigarette consumption, because it
increases the price to consumers. As shown in the figure, the quantity falls to Q3.

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