Chapter 4 Economic Efficiency, Government Price Setting, and Taxes

1) What is producer surplus? What does producer surplus measure? What area on a supply and
demand graph represents consumer surplus?

2) What is marginal benefit? Which curve is also referred to as a marginal benefit curve?

3) Assume the market price for lemon grass is $4.00 per pound, but most buyers are willing to
pay more than the market price. At the market price of $4.00, the quantity of lemon grass
demanded is 1,500 pounds per month, and quantity demanded does not reach zero until the price
reaches $30.00 per pound. Construct a graph showing this data, calculate the total consumer
surplus in the market for lemon grass, and show the consumer surplus on the graph.

4) The marginal cost for Java Joe's to produce its first cup of coffee is $0.75. Its marginal cost to
produce its second cup of coffee is $1.25. Its marginal cost increases by $0.50 for each additional
cup of coffee it produces. Suppose the market price for coffee is $2.25. Construct a graph
showing the producer surplus for each cup of coffee Java Joe's will sell. How many cups of
coffee will Java Joe's sell? What is the value of the producer surplus Java Joe's receives for each
cup of coffee it sells?

5) What is consumer surplus? Why would policy makers be interested in consumer surplus?

6) What is marginal cost? Which curve is also referred to as the marginal cost curve?

7) Assume the market price for tangerines is $18.00 per bushel. At the market price, tangerine
growers are willing to supply a quantity of 12,000 bushels per week. The quantity supplied drops
to zero when the price falls to $5.00 per bushel. Construct a graph showing this data, calculate
the total producer surplus in the market for tangerines, and show the total producer surplus on the
graph.

8) The market price for coffee is $2.25 per cup. Austin is willing to pay $5.00 per cup, Colin is
willing to pay $4.00 per cup, Lucy is willing to pay $3.00 per cup, and Ike is willing to pay $2.00
per cup. Construct a graph showing the consumer surplus for each cup of coffee purchased. How
many cups of coffee will be purchased? What is the value of the consumer surplus each of the
four consumers receives from their coffee purchases?

9) What is economic surplus? When is economic surplus at a maximum?

10) Will equilibrium in a market always result in an outcome that is economically efficient?
Explain.

11) The graph below represents the market for walnuts. Identify the values of the marginal
benefit and the marginal cost at the output levels of 2,000 pounds, 4,000 pounds, and 6,000
pounds. At each of these output levels, state whether output is inefficiently high, inefficiently
low, or economically efficient.

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12) The graph below represents the market for lychee nuts. The equilibrium price is $7.00 per
bushel, but the market price is $5.00 per bushel. Identify the areas representing consumer
surplus, producer surplus, and deadweight loss at the equilibrium price of $7.00 and at the
market price of $5.00.

13) What is deadweight loss? When is deadweight loss equal to zero?

14) The graph below represents the market for alfalfa. The market price is $7.00 per bushel.
Identify the areas representing consumer surplus, producer surplus, and economic surplus.

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15) The graph below represents the market for alfalfa. The equilibrium price is $7.00 per bushel,
but the market price is $9.00 per bushel. Identify the areas representing consumer surplus,
producer surplus, and deadweight loss at the equilibrium price of $7.00 and at the market price of
$9.00.

16) What is the difference between a price ceiling and a price floor? Compared to the
competitive equilibrium price, where must price ceilings and price floors be set to have an effect
on the market.
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17) What is a black market?

18) What is the difference between scarcity and a shortage?

Figure 4-12

19) Refer to Figure 4-12 which shows the market for vitamins. Suppose the government
imposes a price ceiling of Pv. How will the price ceiling affect the quantity supplied, quantity
demanded, and quantity exchanged?

Table 4-9

Price per Quantity Quantity

Bushel Demanded Supplied
(dollars) (bushels) (bushels)
$2 40,000 0
4 34,000 4,000
6 28,000 8,000
8 24,000 16,000
10 20,000 20,000
12 18,000 28,000
14 12,000 36,000
16 6,000 40,000

Table 4-9 above contains information about the corn market. Answer the following questions
based on this table.

20) Refer to Table 4-9. An agricultural price floor is a price that the government guarantees
farmers will receive for a particular crop. Suppose the federal government sets a price floor for
corn at $12 per bushel.
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a. What is the amount of shortage or surplus in the corn market as result of the price floor?
b. If the government agrees to purchase any surplus output at $12, how much will it cost the
government?
c. If the government buys all of the farmers' output at the floor price, how many bushels of corn
will it have to purchase and how much will it cost the government?
d. Suppose the government buys up all of the farmers' output at the floor price and then sells the
output to consumers at whatever price it can get. Under this scheme, what is the price at which
the government will be able to sell off all of the output it had purchased from farmers? What is
the revenue received from the government's sale?
e. In this problem we have considered two government schemes: (1) a price floor is established
and the government purchases any excess output and (2) the government buys all the farmers'
output at the floor price and resells at whatever price it can get. Which scheme will taxpayers
prefer?
f. Consider again the two schemes. Which scheme will the farmers prefer?
g. Consider again the two schemes. Which scheme will corn buyers prefer?

Figure 4-13

21) Refer to Figure 4-13 which shows the market for watermelons. Suppose the government
imposes a price floor of Pw. How will the price floor affect the quantity supplied, quantity
demanded, and quantity exchanged?

Table 4-10

Price Per Quantity Quantity

Bushel Demanded Supplied
(dollars) (bushels) (bushels)
$3 36,000 0
6 30,000 2,000
9 25,000 5,000
12 20,000 10,000
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 15 16,000 16,000
18 13,000 23,000
21 8,000 30,000
24 3,000 36,000

Table 4-10 above contains information about the wheat market. Answer the following questions
based on this table.

22) Refer to Table 4-10. An agricultural price floor is a price that the government guarantees
farmers will receive for a particular crop. Suppose the federal government sets a price floor for
wheat at $21 per bushel.
a. What is the amount of shortage or surplus in the wheat market as result of the price floor?
b. If the government agrees to purchase any surplus output at $21, how much will it cost the
government?
c. If the government buys all of the farmers' output at the floor price, how many bushels of
wheat will it have to purchase and how much will it cost the government?
d. Suppose the government buys up all of the farmers' output at the floor price and then sells the
output to consumers at whatever price it can get. Under this scheme, what is the price at which
the government will be able to sell off all of the output it had purchased from farmers? What is
the revenue received from the government's sale?
e. In this problem we have considered two government schemes: (1) a price floor is established
and the government purchases any excess output and (2) the government buys all the farmers'
output at the floor price and resells at whatever price it can get. Which scheme will taxpayers
prefer?
f. Consider again the two schemes. Which scheme will the farmers prefer?
g. Consider again the two schemes. Which scheme will wheat buyers prefer?

Figure 4-14

Figure 4-14 shows the market for taxi rides. The following question(s) are based on this figure.

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23) Refer to Figure 4-14. To legally drive a taxicab in New York City, you must have a
medallion issued by the city government. Assume that only 13,200 medallions have been issued.
Let's also assume this puts an absolute limit on the number of taxi rides that can be supplied in
New York City on any day, because no one breaks the law by driving a taxi without a medallion.
Assume as well that each taxi provides 6 trips per day. In that case, the quantity of taxi rides
supplied is 79,200 (or 6 rides per taxi × 13,200 taxis). This is shown in the diagram with a
vertical line at this quantity. Assume that there are no government controls on the prices that
drivers can charge for rides.
a. What would the equilibrium price and quantity be in this market if there was no medallion
requirement?
b. If there was no medallion requirement, indicate the area that represents consumer surplus.
c. If there was no medallion requirement, indicate the area that represents producer surplus.
d. If there was no medallion requirement, indicate the area that represents economic surplus.
e. What are the price and quantity with the medallion requirement?
f. With a medallion requirement in place, what area represents consumer surplus?
g. With a medallion requirement in place, what area represents producer surplus?
h. With a medallion requirement in place, what area represents the deadweight loss?
i. Based on your answers to parts (c) and (g), are taxicab drivers better off with the medallion
requirement for taxicabs than without?
j. Are consumers better off with or without the medallion requirement for taxicabs?

24) Using a supply and demand graph, illustrate the market for rent-controlled apartments with
the following data:

Equilibrium rent without rent control: $1,500

Rent with rent control: $700
Quantity of apartments demanded with rent control: 50,000
Quantity of apartments supplied with rent control: 20,000

What is the value of the initial shortage of apartments with rent control?

Now assume rent control leads to a reduction in the supply of apartments, and the new quantity
supplied is now 15,000. Illustrate this on your graph.

What is the value of the shortage of apartments following the decrease in supply?

25) What is "tax incidence"? What determines tax incidence in a competitive market?

26) What do economists mean by an efficient tax?

27) Using a supply and demand graph, illustrate the effect of the addition of a $10.00 per-unit
unit tax on digital cameras, where the entire tax burden falls on the seller. Assume the
equilibrium price before the tax is $125 and the equilibrium quantity is 50,000. What happens to
the price and quantity after the tax is implemented?

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Figure 4-19

28) Refer to Figure 4-19. The figure above illustrates the markets for two goods, Good X and
Good Y. Suppose an identical dollar tax is imposed on sellers in each market.
a. Compare the consumer burden and producer burden in each market. Illustrate your answer
graphically.
b. If the goal of the government is to raise revenue with minimum impact to quantity consumed,
in which market should the tax be imposed?
c. If the goal of the government is to discourage consumption, in which market should the tax
be imposed?

Figure 4-20

29) Refer to Figure 4-20. The figure above represents demand and supply in the market for
gasoline. Use the diagram to answer the following questions.
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a. How much is the government tax on each gallon of gasoline?
b. What portion of the per-unit tax is paid by consumers?
c. What portion of the per-unit tax is paid by producers?
d. What is the quantity sold after the imposition of the tax?
e. What is the after-tax revenue per gallon received by producers?
f. What is the total tax revenue collected by the government?
g. What is the value of the excess burden of the tax?
h. Is this gasoline tax efficient?

30) Is there a difference between the "true burden" of a tax and who is legally required to pay a
tax? Briefly explain.

31) Using a supply and demand graph, illustrate the effect of an increase in the federal cigarette
tax of $1.00 per pack, where the entire tax burden falls on the consumer. Assume the equilibrium
price before the tax is $5.00 per pack and the equilibrium quantity is 30 million packs.

After the implementation of the tax, what are the equilibrium price and equilibrium quantity?

Figure 4-21

32) Refer to Figure 4-21. The figure above represents demand and supply in the market for
cigarettes. Use the diagram to answer the following questions.
a. How much is the government tax on each pack of cigarettes?
b. What portion of the unit tax is paid by consumers?
c. What portion of the unit tax is paid by producers?
d. What is the quantity sold after the imposition of the tax?
e. What is the after-tax revenue per pack received by producers?
f. What is the total tax revenue collected by the government?
g. What is the value of the excess burden of the tax?
h. Is this cigarette tax efficient?

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33) You are given the following market data for Venus automobiles in Saturnia.
Demand is represented by: P = 200 - 0.25Q
Supply is represented by: P = 130 + 0.10Q where P = Price and Q = Quantity.

a. Calculate the equilibrium price and quantity.

b. Calculate the consumer surplus in this market.
c. Calculate the producer surplus in this market.

34) You are given the following market data for apples.
Demand is represented by: P = 12 - 0.01Q
Supply is represented by: P = 0.02Q where P= price per bushel, and Q=quantity.

a. Calculate the equilibrium price and quantity.

b. Suppose the government guaranteed producers a price of $10 per bushel. What would be the
effect on quantity supplied? Provide a numerical value.
c. By how much would the $10 price change the quantity of apples demanded? Provide a
numerical value.
d. Would there be a shortage or surplus of apples?
e. What is the size of this shortage or surplus? Provide a numerical value.

35) You are given the following market data for Venus automobiles in Saturnia.
Demand: P = 35,000 - 0.5Q
Supply: P = 8,000 + 0.25Q where P = Price and Q = Quantity.

a. Calculate the equilibrium price and quantity.

b. Calculate the consumer surplus in this market.
c. Calculate the producer surplus in this market.

36) The demand and supply equations for the peach market are:
Demand: P = 24 - 0.5Q
Supply: P = -6 + 2.5Q where P = price per bushel, and Q = quantity (in thousands).

a. Calculate the equilibrium price and quantity.

b. Suppose the government guaranteed producers a price of $24 per bushel. What would be the
effect on quantity supplied? Provide a numerical value.
c. By how much would the $24 price change the quantity of peaches demanded? Provide
a numerical value.
d. Would there be a shortage or surplus of peaches?
e. What is the size of this shortage or surplus? Provide a numerical value.

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Chapter 6 Elasticity: The Responsiveness of Demand and Supply

1) What does price elasticity of demand measure? When is demand elastic? Inelastic? Unit
elastic?

2) Suppose the price of gasoline in July 2004 averaged $1.35 a gallon and 15 million gallons a
day were sold. In October 2004, the price averaged $2.15 a gallon and 14 million gallons were
sold. If the demand for gasoline did not shift between these two months, use the midpoint
formula to calculate the price elasticity of demand. Indicate whether demand was elastic or
inelastic.

3) The current price of canvas messenger bags is $36 each and sales of the bags equal 400 per
week. If the price elasticity of demand is -2.5 and the price changes to $44, how many messenger
bags will be sold per week? Use the midpoint formula.

4) List the five key determinants of price elasticity of demand and explain how each determinant
indicates if demand tends to be elastic or inelastic.

5) For each pair of items below determine which product would have the higher price elasticity
of demand (in absolute value).
a. Insulin for a diabetic or aspirin for someone suffering a headache.
b. A new Whirlpool 27 cu.ft. side-by-side refrigerator or electricity to power your all-electric
home.
c. A can of Red Bull or soft drinks in general.

6) Explain the concepts of cross-price elasticity of demand and income elasticity of demand.
What do positive and negative values indicate for each of these demand elasticities?

7) Suppose a 4 percent increase in income results in a 2 percent decrease in the quantity

demanded of a good. Calculate the income elasticity of demand for the good and determine what
type of good it is.

8) When the price of Starbucks coffee increased by 8 percent, the quantity demanded of Peet's
coffee increased by 10 percent. Calculate the cross-price elasticity of demand between Starbucks
coffee and Peet's coffee. What is the relationship between the two products?

Table 6-7

Quantities Quantities
Purchased Purchased
Income Prices Good X Good Y
$30,000 Px = $6, Py = $3 2 20
50,000 Px = $6, Py = $4 5 10

9) Refer to Table 6-7.

a. Using the information in the table, calculate the income elasticity of demand for good X and
characterize the good. Use the midpoint formula.
b. Can you calculate the income elasticity of demand for good Y? If you can, show your
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calculation and characterize the good. If you cannot, explain why.

10) Explain the economic concept of price elasticity of supply. How is price elasticity of supply
calculated?

11) Suppose the current price of oil is $90 a barrel and the quantity supplied is 800 million
barrels per day. If the price elasticity of supply for oil in the short run is estimated at 0.5, use the
midpoint formula to calculate the percentage change in quantity supplied when the price of oil
rises to $98 a barrel.

12) Suppose the current price of copper is $3 per pound and the quantity supplied is 200 pounds
per day. If the price of copper falls to $2.50 per pound, the quantity supplied drops to 180 pounds
per day. Use the midpoint formula to calculate the price elasticity of supply for copper.

13) For a given demand curve, will there be a greater loss of economic efficiency from a binding
price floor when supply is elastic or inelastic? Illustrate your answer with a demand and supply
graph. In your graph you must show two supply curves, one elastic and the other inelastic.

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