Assignment
Chapter-6: Problems & Applications: 2, 4, 8
QUESTION 2
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 floor, 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 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 – Q2.
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.
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
QUESTION 2
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 floor, 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 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 – Q2.
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.
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