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e. Producer surplus rises when there is an increase in supply, holding all else constant.
TRUE, because when supply shifts to the right, the area representing producer
surplus becomes a triangle with the same height but a larger base.
Or:
FALSE, because the price falls due to a movement along the demand curve if the
shift is not constant at all quantities.
3. Short Problems
Below you will find two short problems, each worth 15 points. Points for each subsection of
the problem are stated.
a. Cigarette Contradiction? (15 points)
Suppose the U.S. government administers only two programs that affect the market for
cigarettes. Firstly, media campaigns and labeling requirements are aimed at making the
public aware of the dangers of cigarette smoking. Secondly, the Department of
Agriculture maintains a price support program for tobacco, which includes guaranteeing
tobacco farmers a selling price that is above the equilibrium market price (including
paying them for any excess supply).
Answer the following questions using appropriate graphs. Be specific about determinants
of demand and supply affecting the outcomes.
i. What does the awareness campaign do in the cigarette market? (3 points)
The media campaign and labeling requirements are aimed at shifting the
demand curve for cigarettes to the left (a decrease in demand). This shift
will decrease the consumption of cigarettes, and drive down the price of
cigarettes.
ii. What does the price floor for tobacco do in the cigarette market? (5 points)
iii. Are these two programs at odds with each other with respect to the goal of
reducing cigarette consumption? (3 points)
Both programs work towards the goal of reducing cigarette consumption
see combined graphs in part (iv).
iv. What is the combined effect of these two programs on the price of
cigarettes? (4 points)
The first program leads to a lower price of cigarettes, and the second
program leads to a higher price. Whether the combined effect of the two
programs increases or decreases the price of cigarettes depends on the
relative sizes of the two price changes.
The figure on the left shows the combined effect leading to an increase in
price; the figure on the right shows the combined effect leading to a
decrease in price.
For all questions related to the above graph, assume the market wage preceded the
regulated wage.
i. How many more low-skill workers will seek jobs after the government
establishes a minimum wage than did before the minimum wage? (4
points) 2 million more (used to be 6 million, now it's 8 million)
ii. Which of the following statements is true concerning the diagram
presented above? Choose one and explain briefly. (5 points)
A. The government regulated price is a price ceiling and there will be
4 million low-skilled job seekers without jobs once the ceiling has
been established
B. The government regulated price is a price ceiling and there will be
2 million low-skilled job seekers without jobs once the ceiling has
been established
C. The government regulated price is a price floor and there will
be 4 million low-skilled job seekers without jobs once the floor
has been established
D. The government regulated price is a price floor and there will be 2
million low-skilled job seekers without jobs once the floor has
been established
iii. Fill in the blanks (using the letters in the graph above, which represent
areas of respective regions of the graph as shown): Once the regulated
wage is established, the low-skilled laborers economic surplus will
change from HK to HA. (4 points)
iv. Fill in the blank (using the letters in the graph above, which represent
areas of respective regions of the graph as shown): According to the above
diagram, the deadweight loss associated with the government establishing
a minimum wage will be DK. (2 points)
4. Long Problem (40 points)
See below: