Homework 2-     

1. Basic Supply and Demand:

For each of the situations below analyze what happens to the supply and demand curves, and then decide the impact on the equilibrium price and quantity in the particular market.

a. Consider the market for lemonade. Suppose this market is initially in equilibrium and then the price of lemons, a key ingredient in lemonade, increases. What do you predict will happen to the equilibrium price and quantity of lemonade due to this change?

b. Consider the market for lemonade. Suppose this market is initially in equilibrium and then the Surgeon General's Office issues a report highlighting the health benefits from drinking lemonade. Holding everything else constant, what do you predict will happen to the equilibrium price and quantity of lemonade due to this change?

c. Consider the market for lemonade. Suppose this market is initially in equilibrium and then both the price of lemons and the Surgeon General's Report (this events are described in parts (a) and (b)) simultaneously occur. What do you predict will happen to the equilibrium price and quantity of lemonade due to these changes?

d. Consider the market for new cars. Suppose this market is initially in equilibrium and then the government implements an environmental protection rule on producers that results in higher manufacturing costs for all new cars. What do you predict will happen to the equilibrium price and quantity of new cars due to this change?

e. Consider the market for gasoline. Suppose this market is initially in equilibrium and then there is a major disruption in petroleum production in the Middle East due to political instability. At the same time an educational campaign is launched making people aware of the environmental consequences of driving. This educational campaign is successful in reducing the amount of driving that people do. What do you predict will happen to the equilibrium price and quantity of gasoline due to these changes?

2. Supply and Demand:

Suppose there are two demanders, Adam and Eve, of apples in the market for apples. The equation below gives Adam's demand curve for apples. Assume that Eve's demand curve for apples is identical to Adam's demand curve for applies.

P = 5 - (1/2)Q.

a. What is the market demand for apples in this market if Adam and Eve are the only consumers of apples?

b. Suppose that Adam and Eve would both like to consume two apples a piece. What price per apple will they be willing to pay in order to consume this amount of apples?

c. Suppose you are now told that the market supply curve for apples is given by the equation P = (1/3)Q - 2. What is the equilibrium price and quantity of apples in this market?

d. Adam and Eve decide that they like apples even more than they did initially. Suppose that the market demand curve changes and is now P = 12 - (1/4)Q. What is the new equilibrium price and quantity in the market for apples? Assume there is no change in the market supply curve.

e. Suppose that the new market demand curve is the demand curve given in part (d). Now suppose that the supply of apples has increased so that the new market supply curve is given by P = (1/3)(Q + 7) - 2. What is the new equilibrium quantity and price in the apple market?

3. Price Ceilings:

Consider the market for apartment rentals in Madison.  For simplicity let's assume that all apartments in Madison are identical and that we can write the market demand and market supply curves as follows where Q is the quantity of apartments and P is the monthly rental price for an apartment.

Demand: Q_d = 450 - (1/2)P

Supply: Q_s = P - 300

a. What is the equilibrium price and quantity in the market for apartment rentals?

b. What is the value of consumer surplus and producer surplus in the market for apartment rentals? Draw a graph illustrating your answer and then provide a numerical calculation of these two values.

c. Suppose the government decides to enact a price ceiling in the market for apartments in Madison. The price ceiling is set at $600. Given this price ceiling what is the quantity of apartments demanded in this market and what is the quantity of apartments supplied in this market. Is there a shortage or a surplus in the market once the price ceiling is implemented?

d. Suppose the government implements a price ceiling of $400 in the market for apartments in Madison. Given this price ceiling what is the quantity of apartments demanded in this market and what is the quantity of apartments supplied in this market. Is there a shortage or a surplus in the market once the price ceiling is implemented?

4. Excise Tax-

The initial supply and demand curves for beer per day in Madison are given by the following equations:               

Demand: Q_d = 3500 - 500P                           

Supply: Q_s = 1000P - 1000

a. Draw a graph of the supply and demand curves in this market.  On the graph mark the market equilibrium price and quantity, as well as the areas for consumer surplus and producer surplus.

b. Calculate the value of consumer surplus and producer surplus.

During the football season, the demand for beer per day increases a lot, numerically, the demand curve shifts upward (vertically) by 3 units. However, the supply curve doesn't change (The supply is assumed to be unchanged for simplicity. Also, it is not easy to change the supply of beer in a short period of time.)

c. Draw a graph illustrating the new demand curve, the initial demand curve, and the market supply curve. Write down the new demand equation for beer per day during the football season.

d. Calculate the new equilibrium price and quantity of beer per day during the football season. What is the value of consumer surplus and producer surplus per day during football season? How many more beers are consumed per day during the football season compared to beer consumption per day during the rest of the year?

Now suppose that Madison government decides to control the consumption of beers in football season by implementing an excise tax on producers of $1.5 per beer.

e. What happens to the equilibrium quantity and price of beer during football season with this excise tax? Calculate the value of consumer surplus and producer surplus per day in the beer market once this excise tax is implemented. How much tax revenue per day is generated when this excise tax is implemented? What is the amount of deadweight loss per day due to the excise tax?

f. Suppose that government officials want beer consumption to remain the same during football season as it is during the off season. What would the excise tax on beer during the football season need to be in order for beer consumption to stay the same during both seasons?

5. Price Support:

The government institutes a price support program for farmers producing soybeans.  In order to raise farm revenue, the government will establish a price floor in the market for soybeans. The government will purchase any excess supply of soybeans and store them in Madison, WI for $1/lb.  The demand and supply for soybeans are as follows:            

Demand: P = 20 - 4Q_d                   

Supply: P = 2Q_s + 2          

Suppose the government sets the price floor at Pfloor = $10/lb of soybeans. 

a. Calculate the equilibrium price and quantity without the price floor, and plot the demand and supply curves in a graph. In your graph mark the initial equilibrium price and quantity. On your graph identify the y-intercept and x-intercept for the demand curve and the y-intercept for the supply curve.  

b. Suppose the government institutes the price floor of $10/lb of soybeans. Draw a new graph that illustrates this market now that there is a price floor of $10/lb of soybeans in the market. How many units of soybeans will be supplied with this program? How many units of soybeans will be demanded by consumers with this program? How many units of soybeans will the government purchase with this program? What is the cost to the government, net of storage costs, for this program? What is the total cost to the government, including storage costs, for this program? In your graph shade the area that represents the cost to the government net of storage costs.

c. Now, using the same demand and supply schedules, draw a new graph where the government uses a price subsidy program instead of a price floor program.  There is no longer a cost for storage, and the guarantee price equals the floor price, Pguarantee = $10.  How many units of soybeans will be supplied with this program? How many units of soybeans will be demanded by consumers with this program? How many units of soybeans will the government purchase with this program? What is the total cost to the government for this program? Shade the area that represents the total cost to the government for this program on your new graph.