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ch10 - Chapter 10 Competitive Markets Applications...

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Chapter 10 Competitive Markets: Applications Solutions to Review Questions 1. In a long-run equilibrium, a competitive market allocates resources efficiently. As Adam Smith wrote over 200 years ago, it is as though there is an “Invisible Hand” guiding a competitive market to the efficient level of production and consumption. This occurs through producers and consumers acting in their own self-interest to maximize profits and utility. 2. In a competitive market with no government intervention there is no deadweight loss. 3. The incidence of the tax refers to who ultimately pays the tax. In general, when the government imposes a tax, consumers and producers share the tax burden to some degree. The incidence of the tax refers to how the tax is shared. The incidence of the tax depends on the shapes of the supply and demand curves. If demand is relatively inelastic compared with supply, consumers will bear most of the burden of the tax, whereas if supply is relatively inelastic compared with demand, producers will bear most of the burden of the tax. 4. Since demand is relatively inelastic compared with supply, most of the burden of the tax will rest with the consumers. 5. No, this is not reasonable. The incidence of the tax can be summarized quantitatively as , , s d d Q P s Q P P P ε ε = Using the figures given in this problem, , , , , 1.2 0.9 1.33 s d s d Q P Q P Q P Q P ε ε ε ε = - = - Page 10 - 1
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This implies the price consumers pay will increase by about 1.33 times as much as the decrease in the price producers receive. Thus, if the tax is $10, consumers will bear $5.70 of the tax and producers will bear $4.30 of the tax. We would therefore expect the market price to rise by $5.70, not the $10 the newspaper suggested. 6. If the government provides a subsidy, consumer surplus will increase and producer surplus will increase. The market will have a deadweight loss, however, because these increases will be outweighed by the impact on the government treasury. 7. Price ceilings and price floors will not always make consumers and producers better off. In particular, if the price ceiling is set above the equilibrium price or if the price floor is set below the equilibrium price, the price ceilings and floors will have no effect. In addition, depending on which consumers or producers are able to purchase in or supply to the market, consumer surplus or producer surplus may be lower after the imposition of the price ceiling or price floor. 8. Producer surplus may increase. If the most efficient producers serve the market, producer surplus will increase for some levels of the quota. However, if the quota is too low (for example, close to zero), producer surplus could actually decrease. 9. One outcome of these programs is to increase farmers’ producer surplus. As the text states, a government must often spend much more than one dollar to increase farmers’ surplus by one dollar. Since these programs tend to be more politically palatable than direct cash payments to farmers, however, governments tend to implement these types of programs.
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