ARE120Homework1_spring08_KEY - University of California...

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University of California, Davis Agricultural and Resource Economics 120, Spring 2008 Julian Alston Homework #1 Solutions 1. Cheap food policy If a maximum price is set at P MAX , Q D units will be demanded and Q S units will be supplied. Thus, there is clearly excess demand. The important question, then, is how does the market clear? The answer involves some type of non-price rationing, or queuing. This market could clear in a number of ways, depending on the degree of enforcement and the rules governing the queue. We’ll assume perfect enforcement, so that only Q S units are sold. Relevant rules concerning the queue include the number of units that can be purchased in one trip through the line, the number of times a person can go through the line during a given time, and whether or not trading is permitted. We are comparing two static equilibria, so when thinking about how the market clears, it is helpful to ask: “Can the buyer or seller take additional steps to get or to provide another unit at a cost below the added gain? If the answer Q D S Q D Q S P MAX P A F E D C B A P
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is yes, an equilibrium has not yet been reached” (Yoram Barzel, “Economic Analysis and Property Rights,” 1989, p. 19). In other words, if there exists an opportunity for anyone to make money in this market, it is not at equilibrium. We’ll use this rule of thumb to evaluate various methods for rationing the quantity Q S of food. a. Black Market If the queue rules are the least restrictive, so that a person may buy as many units of food as s/he desires in one trip through the line and trading is permitted, a black market will likely develop. The first person in line would buy all the food at price P MAX , then sell it at the price consumers are willing to pay, P A , making a profit of area B+D. However, if someone else got to the line first, s/he could snag the black marketer’s profit. Thus, there is a strong incentive to be the first in line. But, being first in line is not free, as it means getting there early and spending a lot of time waiting. At the equilibrium, the cost of being first in line will be bid up until it equals the potential profits, area B+D. Thus, consumers pay price P A and lose area B+C, producers receive price P MAX and lose area D+E, and the black market earns and spends area B+D, for a DWL to society of B+C+D+E. b. Paying Someone to Wait This is similar to the black market case, but is a more likely outcome when trading is allowed once the food is purchased, but there are limits on the amount of food that can be purchased in one trip through the queue. Consumers with a high willingness to pay for food, but a high opportunity cost of time could pay someone else (with a lower opportunity cost) to wait in line for them. In this case, the “waiters” must be exactly compensated for the value of the time they spend in line. If they were underpaid, another consumer with a higher willingness to pay
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ARE120Homework1_spring08_KEY - University of California...

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