SYED ATIF ALI GR NO. 230633 ASSIGNMENT NO.

3 MICRO ECONOMICS

Chapter 6

Questions for Review Q1. Ans. A price ceiling is a government-imposed limit on the price charged for a product. Governments intend price ceilings to protect consumers from conditions that could make necessary commodities unattainable. e.g. the example of price ceiling is the prices of "rotti" in Pakistan; government set the price Rs. 2.00 per rotti which is low than the equilibrium price.

Price floor - floor below which prices are not allowed to fall; "the government used price supports to maintain the price floor". e.g. this is commonly seen in agriculture. Often the government wishes to maintain high prices of agricultural goods to keep a large number of farmers working. To limit the surplus, however, governments often pay some farmers not to plant crops; this can be known as a subsidy check. Price floors are also commonly imposed on the hospitality industry. Q2. Ans. A price ceiling may cause a shortage, but it will also enable a certain portion of the population to purchase a product that they couldn't afford at market costs. A price floor will be a price set above equilibrium - this creates a surplus.

Q4. Ans. The primary criticism leveled against price controls is that by keeping prices artificially low, demand is increased to the point where supply can not keep up, leading to shortages in the price-controlled product. Shortages, in turn, lead to black markets where prices for the same good exceed those of an uncontrolled market. Furthermore, once controls are removed, prices will immediately increase, which can temporarily shock the economic system.

Q6 Ans. Taxes on a Buyer are commonly excised through a sales tax as a percentage of the price of the good. The imposed cost by the government affects the equilibrium by shifting the demand curve downward by the amount of the tax. The tax burden is shared by the seller and buyer; the seller receives less for the good in the new tax equilibrium, while the buyer pays more for the good. Taxes

on the Seller are not directly levied on the buyer but on the seller. This creates an upward shift in the supply curve by the amount of the tax, and creates a new equilibrium in the market. With the upward shift of the supply curve the demand moves from a greater quantity to a lesser quantity. This increases the buyer's purchase price while simultaneously lowering the amount received by the seller.

Problems and Application

Q1. Ans. If the price ceiling of $40 per ticket is below the equilibrium price, then quantity demanded exceeds quantity supplied, so there will be a shortage of tickets. The policy decreases the number of people who attend classical music concerts, because the quantity supplied is lower because of the lower price.

Q2. Ans. a. The imposition of a binding price floor in the cheese market is shown in figure below. In the absence of the price floor, the price would be P1 and the quantity would be Q1. With the floor set at Pf, which is greater than P1, the quantity demanded is Q2, while quantity supplied is Q3, so there is a surplus of cheese in the amount Q3 Q2.

b.

The farmers complaint that their total revenue has declined is correct if demand is elastic. With elastic demand, the percentage decline in quantity would exceed the percentage rise in price, so total revenue would decline. c. If the government purchases all the surplus cheese at the price floor, producers benefit and government lose. Producers would produce quantity Q3 of cheese, and their total revenue would increase substantially. However, consumers would buy only quantity Q2 of cheese, so they are in the same position as before.