Homework 2-

1. Supply and Demand: Basic Review:

a. For each of the following situations identify whether there is a shift or a movement along the demand curve, a shift or a movement along the supply curve, the effect on the equilibrium price relative to the initial level, and the effect on the equilibrium quantity relative to the initial level. In the case of a shift identify the direction of the shift (right or left).

b. Suppose you are told that the initial demand curve for good X is P = 100 - Q. You are then told that incomes increase in this economy and that good X is a normal good. If you know that the quantity demanded of good X changes by 5 units at every price, what is the equation for the new demand curve?

c. Suppose you are told that the initial supply curve for good Y is P = 1000 + 2Q. You are then told that the number of firms in the industry producing good Y increases so that at every price 200 additional units of good Y are now produced. What is the new supply equation for good Y?

d. Suppose you are told that at the initial demand curve for good Z is P = 100 - 2Q. Furthermore, you are told that demanders tastes and preferences change so that at every price twice as much of good Z is demanded as was demanded initially. What is the equation for the new demand curve? (Hint: Be careful here and really think about this thoroughly-you might want to consider several different (quantity, price) combinations to see what is happening!)

2. Supply and Demand: Indeterminancy:

a. In the market for corn flakes the price of cardboard used in packing the cereal has risen at the same time that the Surgeon General releases a report detailing the dangers of a diet high in corn products. What happens to the equilibrium price and equilibrium quantity relative to the initial equilibrium before these two changes?

b. In the market for bottled water people realize that drinking bottled water causes significant environmental damage due to the waste issues posed by plastic bottles. At the same time, scientists release a study documenting the beneficial effects of drinking water from naturally occurring aquifers (the underground storage place for water that provides the water for bottled water). What happens to the equilibrium price and equilibrium quantity relative to the initial equilibrium before these two changes?

c. In the market for insulation, people realize that they can substantially reduce the costs of their winter heating bills if their houses are well insulated. At the same time, the government in an effort to increase clean energy jobs passes a law subsidizing insulation producers. What happens to the equilibrium price and equilibrium quantity relative to the initial equilibrium before these two changes?

d. In the market for chocolate, people read that the consumption of  chocolate has major health benefits. At the same time, the cost of growing and harvesting cocoa beans increases. What happens to the equilibrium price and equilibrium quantity relative to the initial equilibrium before these two changes?

3. Supply and Demand; Price Floors and Price Ceilings:

a. Consider the market for ipods. The government decides to impose a price ceiling on ipods. You are told that this is an effective price ceiling. Describe what would make this an effective price ceiling.

b. Consider the market for bicycles. The government decides to impose a price floor in this market of $100 per bicycle. If the demand curve for bicycles is P = 1,000 - 2Q and the supply curve for bicycles is P = .5Q, then what is the effect of the price floor on the market for bicycles?

c. Consider the market for bicycles. The government decides to impose a price floor in this market of $250 per bicycle. If the demand curve for bicycles is P = 1,000 - 2Q and the supply curve for bicycles is P = .5Q, then what is the effect of the price floor on the market for bicycles?

4. Agricultural Market Interventions:

Use the following information about an agricultural market for cotton to answer this set of questions. The market demand curve for cotton is given by the equation P = 200 - .005Q while the market supply curve is given by the equation P = .005Q where P is the price per bale of cotton and Q is number of bales of cotton.

a. What is the equilibrium price and quantity in this market?

b. Suppose cotton farmers successfully lobby the legislature to impose a price floor of $150 per bale of cotton. Based on this information provide the answers to the following questions.

i. What price will a bale of cotton sell for once the legislature passes the price floor legislation?

ii. How many bales of cotton will be sold to consumers with the imposition of this price floor?

iii. How many bales of cotton will be sold to the government with the imposition of this price floor?

iv. What is the cost to the government of this program assuming that there are no storage costs?

c. Suppose that instead of a price floor, the legislature imposes a price support program with a guaranteed price of $150 per bale of cotton. Based on this information provide the answers to the following questions.

i. What price will a bale of cotton sell for to consumers once the legislature passes the price support legislation?

ii. How many bales of cotton will be sold to consumers with the imposition of this price support?

iii. How many bales of cotton will be sold to the government with the imposition of this price support?

iv. What is the cost to the government of this program assuming that there are no storage costs?

d. In this example the programs described in parts (b) and (c) cost the government the same amount. Is this result always true? Explain your answer carefully.

5. Tariffs, Quotas and Trade:

Use the following information about a small economy to answer this next set of questions. Assume that initially this small economy is closed to trade. You are told that the domestic demand for widgets is given by the equation P = 2500 - 5Qd where Qd  is the quantity of domestically demanded widgets and P is the widget price and the domestic supply of widgets is given by the equation P = 20Qs where Qs is the quantity of domestically supplied widgets. The world price of widgets is $1500.

a. Assuming that this economy's market for widgets is closed to international trade, what is the equilibrium price and quantity of widgets?

b. Suppose this economy opens its widget market to international trade. Describe the impact of this opening of the market for widgets: in your answer describe whether the economy imports or exports widgets, identify the numerical value of these imports or exports, and identify the price of widgets.

c. Suppose that domestic producers of widgets go to Congress and successfully lobby for the imposition of a quota for the widget markets. This quota results in the price of widgets in this small open economy increasing to $1800. What is the amount of the quota given this information?

d. For the quota described in part (c) compute the value of consumer surplus with the quota, the value of producer surplus with the quota, the value of license holder revenue, and the deadweight loss due to the quota.

e. Suppose that instead of a quota Congress implements a tariff in the widget market. Suppose this tariff results in 60 widgets being imported into this market? What is the price of widgets in the small economy with the imposition of the tariff?

f. For the tariff described in part (e) compute the value of consumer surplus with the tariff, the value of producer surplus with the tariff, the tax revenue from the tariff, and the deadweight loss due to the tariff.

6. Excise Tax:

Use the following information to answer this question. Suppose there is a market for bicycles in Wheelerville that can be described by the following demand and supply equations:

Demand: Q = 200 - (1/5)P

Supply: Q = (1/5)P - 40

Where Q refers to the quantity of bicycles and P is the price of a bicycle.

a. What is the equilibrium price and equilibrium quantity of bicycles in Wheelerville? Calculate the value of consumer surplus, producer surplus, and total surplus in this market.

b. Suppose an excise tax of $50 per bicycle is imposed on bicycle producers in this market? What is the new equilibrium price and equilibrium quantity of bicycles in this market with the imposition of the excise tax? What is the net price received by bike producers when this excise tax is implemented? What is the economic burden of the excise tax on consumers (consumer tax incidence)? What is the economic burden of the excise tax on producers (producer tax incidence)?

 c. Given the excise tax described in part (b), calculate the value of the excise tax revenue. What is the value of producer surplus with the excise tax? What is the value of consumer surplus with the excise tax? What is the deadweight loss due to the imposition of the excise tax?