Key to Chapter 67.docx

Key to Chapter 67.docx

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KeytoChapter67

Chapter6

SOLUTIONSTOTEXTPROBLEMS:

QuickQuizzes

1.Apriceceilingisalegalmaximumonthepriceatwhichagoodcanbesold.Examplesofpriceceilingsincluderentcontrol,pricecontrolsongasolineinthe1970s,andpriceceilingsonwaterduringadrought.Apricefloorisalegalminimumonthepriceatwhichagoodcanbesold.Examplesofpricefloorsincludetheminimumwageandfarm-supportprices.Apriceceilingleadstoashortage,iftheceilingisbinding,becausesupplierswon’tproduceenoughgoodstomeetdemandunlessthepriceisallowedtoriseabovetheceiling.Apricefloorleadstoasurplus,ifthefloorisbinding,becausesuppliersproducemoregoodsthanaredemandedunlessthepriceisallowedtofallbelowthefloor.

2.Withnotax,asshowninFigure6-1,thedemandcurveisD1andthesupplycurveisS.TheequilibriumpriceisP1andtheequilibriumquantityisQ1.Ifthetaxisimposedoncarbuyers,thedemandcurveshiftsdownbytheamountofthetax（$1000）toD2.ThedownwardshiftinthedemandcurveleadstoadeclineintheequilibriumpricetoP2（theamountreceivedbysellersfrombuyers）andadeclineintheequilibriumquantitytoQ2.ThepricereceivedbysellersdeclinesbyP1-P2,showninthefigureasPS.BuyerspayatotalofP2+$1,000,anincreaseinwhattheypayofP2+$1,000-P1,showninthefigureasPB.

Figure6-1

Ifthetaxisimposedoncarsellers,asshowninFigure6-2,thesupplycurveshiftsupbytheamountofthetax（$1000）toS2.TheupwardshiftinthesupplycurveleadstoariseintheequilibriumpricetoP2（theamountreceivedbysellersfrombuyers）andadeclineintheequilibriumquantitytoQ2.ThepricepaidbybuyersdeclinesbyP1-P2,showninthefigureasPB.SellersreceiveP2andpaytaxesof$1,000,receivingonnetP2-$1,000,adecreaseinwhattheyreceivebyP1-（P2-$1,000）,showninthefigureasPS.

Figure6-2

QuestionsforReview

1.AnexampleofapriceceilingistherentcontrolsysteminNewYorkCity.Anexampleofapriceflooristheminimumwage.Manyotherexamplesarepossible.

2.Ashortageofagoodariseswhenthereisabindingpriceceiling.Asurplusofagoodariseswhenthereisabindingpricefloor.

3.Whenthepriceofagoodisnotallowedtobringsupplyanddemandintoequilibrium,somealternativemechanismmustallocateresources.Ifsupplyexceedsdemand,sothatthere’sasurplusofagoodasinthecaseofabindingpricefloor,sellersmaytrytoappealtothepersonalbiasesofthebuyers.Ifdemandexceedssupply,sothatthere’sashortageofagoodasinthecaseofabindingpriceceiling,sellerscanrationthegoodaccordingtotheirpersonalbiases,ormakebuyerswaitinline.

4.Economistsusuallyopposecontrolsonpricesbecausepriceshavethecrucialjobofcoordinatingeconomicactivitybybalancingdemandandsupply.Whenpolicymakerssetcontrolsonprices,theyobscurethesignalsthatguidetheallocationofsociety’sresources.Further,pricecontrolsoftenhurtthosetheyaretryingtohelp.

5.Ataxpaidbybuyersshiftsthedemandcurve,whileataxpaidbysellersshiftsthesupplycurve.However,theoutcomeisthesameregardlessofwhopaysthetax.

6.Ataxonagoodraisesthepricebuyerspay,lowersthepricesellersreceive,andreducesthequantitysold.

7.Theburdenofataxisdividedbetweenbuyersandsellersdependingontheelasticityofdemandandsupply.Elasticityrepresentsthewillingnessofbuyersorsellerstoleavethemarket,whichinturnsdependsontheiralternatives.Whenagoodistaxed,thesideofthemarketwithfewergoodalternativescannoteasilyleavethemarketandthusbearsmoreoftheburdenofthetax.

ProblemsandApplications

1.Ifthepriceceilingof$40perticketisbelowtheequilibriumprice,thenquantitydemandedexceedsquantitysupplied,sothere’sashortageoftickets.Thepolicydecreasesthenumberofpeoplewhoattendclassicalmusicconcerts,sincesupplyislowerbecauseofthelowerprice.

2.a.TheimpositionofabindingpricefloorinthecheesemarketisshowninFigure6-3.Intheabsenceofthepricefloor,thepricewouldbeP1andthequantitywouldbeQ1.WiththefloorsetatPf,whichisgreaterthanP1,thequantitydemandedisQ2,whilequantitysuppliedisQ3,sothereisasurplusofcheeseintheamountQ3-Q2.

b.Thefarmers’complaintthattheirtotalrevenuehasdeclinediscorrectifdemandiselastic.Withelasticdemand,thepercentagedeclineinquantitywouldexceedthepercentageriseinprice,sototalrevenuewoulddecline.

c.Ifthegovernmentpurchasesallthesurpluscheeseatthepricefloor,producersbenefitandtaxpayerslose.ProducerswouldproducequantityQ3ofcheese,andtheirtotalrevenuewouldincreasesubstantially.ButconsumerswouldbuyonlyquantityQ2ofcheese,sotheyareinthesamepositionasbefore.Taxpayerslosebecausetheywouldbefinancingthepurchaseofthesurpluscheesethroughhighertaxes.

Figure6-3

3.a.Theequilibriumpriceoffrisbeesis$8andtheequilibriumquantityis6millionfrisbees.

b.Withapricefloorof$10,thenewmarketpriceis$10sincethepricefloorisbinding.Atthatprice,only2millionfrisbeesaresold,sincethat’sthequantitydemanded.

c.Ifthere’sapriceceilingof$9,ithasnoeffect,sincethemarketequilibriumpriceis$8,belowtheceiling.Sotheequilibriumpriceis$8andtheequilibriumquantityis6millionfrisbees.

4.a.Figure6-4showsthemarketforbeerwithoutthetax.TheequilibriumpriceisP1andtheequilibriumquantityisQ1.Thepricepaidbyconsumersisthesameasthepricereceivedbyproducers.

Figure6-4

Figure6-5

b.Whenthetaxisimposed,itdrivesawedgeof$2betweensupplyanddemand,asshowninFigure6-5.ThepricepaidbyconsumersisP2,whilethepricereceivedbyproducersisP2-$2.ThequantityofbeersolddeclinestoQ2.

5.Reducingthepayrolltaxpaidbyfirmsandusingpartoftheextrarevenuetoreducethepayrolltaxpaidbyworkerswouldnotmakeworkersbetteroffbecausethedivisionoftheburdenofataxdependsonsupplyanddemand,notwhomustpaythetax.Sincethetaxwedgewouldbelarger,it’slikelythatbothfirmsandworkers,whosharetheburdenofanytax,wouldbeworseoff.

6.Ifthegovernmentimposesa$500taxonluxurycars,thepricepaidbyconsumerswillriselessthan$500,ingeneral.Theburdenofanytaxissharedbybothproducersandconsumersthepricepaidbyconsumersrisesandthepricereceivedbyproducersfalls,withthedifferencebetweenthetwoequaltotheamountofthetax.Theonlyexceptionswouldbeifthesupplycurvewereperfectlyelasticorthedemandcurvewereperfectlyinelastic,inwhichcaseconsumerswouldbearthefullburdenofthetaxandthepricepaidbyconsumerswouldrisebyexactly$500.

7.a.Itdoesn’tmatterwhetherthetaxisimposedonproducersorconsumerstheeffectwillbethesame.Withnotax,asshowninFigure6-6,thedemandcurveisD1andthesupplycurveisS1.Ifthetaxisimposedonproducers,thesupplycurveshiftsupbytheamountofthetax（50cents）toS2.ThentheequilibriumquantityisQ2,thepricepaidbyconsumersisP2,andthepricereceived（aftertaxesarepaid）byproducersisP2-50cents.Ifthetaxisinsteadimposedonconsumers,thedemandcurveshiftsdownbytheamountofthetax（50cents）toD2.Thedownwardshiftinthedemandcurve（whenthetaxisimposedonconsumers）isexactlythesamemagnitudeastheupwardshiftinthesupplycurvewhenthetaxisimposedonproducers.Soagain,theequilibriumquantityisQ2,thepricepaidbyconsumersisP2（includingthetaxpaidtothegovernment）,andthepricereceivedbyproducersisP2-50cents.

Figure6-6

Figure6-7

b.Themoreelasticisthedemandcurve,themoreeffectivethistaxwillbeinreducingthequantityofgasolineconsumed.Greaterelasticityofdemandmeansthatquantityfallsmoreinresponsetotheriseinthepriceofgasoline.Figure6-7illustratesthisresult.DemandcurveD1representsanelasticdemandcurve,whiledemandcurveD2ismoreinelastic.TogetthesametaxwedgebetweendemandandsupplyrequiresagreaterreductioninquantitywithdemandcurveD1thanfordemandcurveD2.

c.Theconsumersofgasolinearehurtbythetaxbecausetheygetlessgasolineatahigherprice.

d.Workersintheoilindustryarehurtbythetaxaswell.Withalowerquantityofgasolinebeingproduced,someworkersmaylosetheirjobs.Withalowerpricereceivedbyproducers,wagesofworkersmightdecline.

8.a.Figure6-8showstheeffectsoftheminimumwage.Intheabsenceoftheminimumwage,themarketwagewouldbew1andQ1workerswouldbeemployed.Withtheminimumwage（wm）imposedabovew1,themarketwageiswm,thenumberofemployedworkersisQ2,andthenumberofworkerswhoareunemployedisQ3-Q2.TotalwagepaymentstoworkersareshownastheareaofrectangleABCD,whichequalswmtimesQ2.

b.Anincreaseintheminimumwagewoulddecreaseemployment.Thesizeoftheeffectonemploymentdependsonlyontheelasticityofdemand.Theelasticityofsupplydoesn’tmatter,becausethere’sasurplusoflabor.

c.Theincreaseintheminimumwagewouldincreaseunemployment.Thesizeoftheriseinunemploymentdependsonboththeelasticitiesofsupplyanddemand.Theelasticityofdemanddeterminesthequantityoflabordemanded,theelasticityofsupplydeterminesthequantityoflaborsupplied,andthedifferencebetweenthequantitysuppliedanddemandedoflaboristheamountofunemployment.

d.Ifthedemandforunskilledlaborwereinelastic,theriseintheminimumwagewouldincreasetotalwagepaymentstounskilledlabor.Withinelasticd