Answers to End-of-Chapter Questions in Chapter 3
Assume that the (weekly) market demand and supply of tomatoes are given by the following figures:
|Price (£ per kilo) |4.00 |3.50 |3.00 |2.50 |2.00 |1.50 |1.00 | |Qd (000 kilos) |30 |35 |40 |45 |50 |55 |60 | |Qs (000 kilos) |80 |68 |62 |55 |50 |45 |38 |
What are the equilibrium price and quantity?
What will be the effect of the government fixing a minimum price of
(i) £3.00 per kilo; (ii) £1.50 per kilo?
Suppose that the government paid tomato producers a subsidy of £1.00 per kilo. (i) Give the new supply schedule. (ii) What will be the new equilibrium price? (iii) How much will this cost the government?
Alternatively, suppose that the government guaranteed tomato producers a price of £2.50 per kilo. (i) How many tomatoes would it have to buy in order to ensure that all the tomatoes produced were sold? (ii) How much would this cost the government?
Alternatively suppose it bought all the tomatoes produced at £2.50. (i) At what single price would it have to sell them in order to dispose of the lot? (ii) What would be the net cost of this course of action?
Equilibrium is where quantity demanded equals quantity supplied: where
P = £2.00 per kilo; Q = 50 000 kilos
There will be a surplus of 22 000 kilos (i.e. 62 000 – 40 000)
No effect. The equilibrium price of £2.00 is above the minimum.
With the £1.00 subsidy, producers will supply at each price the amount that they were previously willing to supply for £1 more. The schedules will now be as follows:
|Price (£ per kilo) |4.00 |3.50 |3.00 |2.50 |2.00 |1.50 |1.00 | |Qd (000 kilos) |30 |35 |40 |45 |50 |55 |60 | |Qs (000 kilos) | | |80 |68 |62 |55 |50 |
The new equilibrium price will be £1.50 (where quantity demanded and the new quantity supplied are equal).
(iii) The cost will be £1 ( 55 000 = £55 000.
At a price of £2.50, (original) supply exceeds demand by 10 000 kilos. The government would therefore have to buy this amount in order to ensure that all the tomatoes produced were sold.
£2.50 ( 10 000 = £25 000
It would have purchased 55 000. To dispose of all these, price would have to fall to £1.50.
The cost of this course of action would be (£2.50 – £1.50) ( 55 000 = £55 000. 2.
Think of two things that are provided free. In each case, identify when and in what form a shortage might occur. In what ways are/could these shortages be dealt with? Are they the best solution to the shortages?
The state provides various goods and services free at the point of use (albeit at a cost to the taxpayer). Two examples are:
(i) Higher education
More people want places in higher education than there are places available. Rationing takes place largely by entry qualification (e.g. A level results). Universities typically adjust their entry requirements to match demand and supply. Others keep the qualification ‘price’ below equilibrium, and simply operate on a ‘first come, first served’ basis. In other words, they close their books when they have filled all their places. Such solutions are generally seen to be fairer than charging for education and then adjusting the (money) price to balance demand and supply. [Of course, there are monetary costs of studying in higher education – books, accommodation, travel to the university/college, etc. This means that there is some rationing through price. Poor people/families may not be able to afford higher...
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