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Unformatted text preview: Hillary Silva International Business MICROECONOMICS. BLOCK 3: 1. Consider the following supply and demand curves in the market for oranges: Supply: P=20+Q Demand: P=80–5Q where Q = millions of crates, and P = euros per crate. a) Compute the equilibrium and show this situation in a graph.
20+Q= 80- 5Q → Q= 10 P=30 b) At this equilibrium P and Q, what is the consumer surplus value, the producer
surplus value and the total surplus value?
Consumer Surplus: (50x10)/2= 250 Producer Surplus: (10x10)/2= 50 Total Surplus: 250+ 50= 300 Hillary Silva International Business c) If the government levies an excise (unit) tax of 6.00€ per bushel on all orange
producers, the supply curve will shift by the amount of the tax. Derive an
equation for the new supply curve, and show this curve in the previous graph.
P= 20+Q (1+6) New supply curve: P= 26+ Q d) Solve for the new equilibrium P and Q, and show this equilibrium point on your graph. And, what is the new price of oranges to consumers? And the new price
received by producers.
Supply: P=26+ Q Demand: P= 80-5Q Q= 9 P=35 New price - buyers: 35€ New price - sellers: 35-6= 29€ Hillary Silva International Business e) What quantity and proportion of the 6.00€ unit tax has been borne by orange
consumers? And by the orange producers?
First price: 30€ → Second price: 35€ With the tax, there’s a new Price=35€/unit, so the buyers now have to pay 5€ more, and sellers Price=35€!unit, but 6€ of these price go to the government, so in reality sellers only are earning 29€, that’s means 1€ less than before the tax. In this case we can say that buyers are borning more tan the producers. f) What are the total tax revenues collected by the government on orange sales?
Show this area on your graph.
Tax revenues: 6x9= 54 g) At this new equilibrium P and Q, what is the consumer surplus value, the
producer surplus value and the total surplus value?
Consumer surplus: (9x 45)/2= 202.5 Producer surplus: (9x9)/2= 40.5 Total surplus: 202.5 + 40.5= 243 Hillary Silva International Business h) Because of the tax, consumer surplus has changed, and producer surplus has
changed too. Due to this government intervention, should appear a deadweight, or welfare loss. Compute and show this welfare loss on your graph.
Total surplus – (Total surplus with the tax + tax revenues) 300 – (243 + 54) = 300 – 297= 3] The walfare loss is the area formed by the triangle between CEA 2. The Small Electric Vehicle (SEV) has become very popular in the European cities. Domestic producers, however, face stiff competition in the form of foreign imports. There has been a continuing cry by domestic producers for trade restrictions. Suppose that the demand for small electric vehicles by European consumers is given by QD = 96 – P, where Qd is quantity demanded per week and P is price measured in hundreds of euros. Supply by domestic producers is QS = P, where Qs measures quantity supplied per week. a) Compute the market equilibrium for SEVs and show this situation in a graph. Qd= 96-P Qs=P Qd=Qs 96-P= P Pe= 48 Qe= 48 Hillary Silva International Business b) Identify the consumer and producer surpluses on your graph, and quantify the consumer surplus value and the producer surplus value. Consumer surplus= 96x48/2 Producer surplus= 96x48/2 c) Now suppose that a foreign manufacturer is willing to supply as many SEVs as can be sold at a price of 24.00€ (hundreds of euros). Graph the import supply curve implied by this price, and label this curve as World Suppy. Then, get the 2 new market equilibrium and the values for the new quantity demanded, the quantity supplied by domestic producers and the quantity imported. Qs= 96-p P= 24 Qs= 96-24 Qs= 72 d) Solve for the new equilibrium P and Q, and show this equilibrium point on your graph. And, what is the new price of oranges to consumers? And the new price received by producers. Qd= 96-P Qs= 72 Hillary Silva International Business 3. A departure from equilibrium pricing usually causes a deadweight loss. Consider the diagram of a market that is at equilibrium at point e where price is Pe and quantity is Qe: a) At equilibrium, the consumer surplus is equal to the area KGE, and the producer surplus is equal to the area GEA. b) Suppose that a price ceiling is imposed at p1 so that producers want to sell Q1 units and consumers want to buy Q2 units. Because Q1 units will be traded, consumers are willing to pay the price P2 but producers receive price P1. Producer surplus now varies to area BCA, and consumer surplus changes to area KBIC. The sum of consumer and producer surplus is (less, more) than before the price ceiling, and deadweight loss is created equal to the area IEC. Can you tell who gains and who loses under a price ceiling? Consider producers, consumers, and society in your answer. Consumers would win with a price ceiling, the consumer surplus increase. However, producers lose, its surplus its reduced. Otherwise, even consumer surplus increase, the total surplus decrease and it appears a deadweight loss. Therefore, a price ceiling is bad for the society in general even it is good for consumers. The efficiency is also reduced and it appears shortage. c) Suppose instead that a price floor is imposed at p2 so that producers want to sell Q2 units and consumers want to buy Q1 units. Consumers are willing to pay the price P2 and producers receive the price P2. Producer surplus is equal to the area ACIH, and consumer surplus is equal to the area Hillary Silva International Business KHI. The sum of consumer and producer surplus is (less, more) than before the price floor, and deadweight loss is created equal to the area IEC. Can you tell who gains and who loses under a price floor? Consider producers, consumers, and society in your answer. Producers win due to the increase on producer surplus. On the other hand, consumer surplus would decrease so consumers would lose. The increase of producers’ surplus is lower than the decrease of consumers’ surplus so the total surplus decrease and the society lose. 4. The government decides to reduce air pollution by reducing the use of petrol. It imposes € 0.50 tax for each litre of petrol sold. a) Should it impose this tax on petrol companies or motorists? Explain carefully, using a supply and demand diagram. It does not matter whether the tax is imposed on producers or consumers, the effect will be the same. With no tax, as shown in the graph, the demand curve is D1 and the supply curve is S1. If the tax is imposed on producers, the supply curve shifts up by the amount of the tax (0.5€) to S2. Then the equilibrium quantity is Q2, the price paid by consumers is P2, and the price received (after taxes are paid) by producers is P2 – 50 cents. If the tax is instead imposed on consumers, the demand curve shifts down by the amount of the tax (0.5€) to D2. The downward shift in the demand curve (when the tax is imposed on consumers) is exactly the same magnitude as the upward shift in the supply curve when the tax is imposed on producers. So again, the equilibrium quantity is Q2, the price paid by consumers is P2 (including the tax paid to the government), and the price received by producers is P2 – 50 cents. Hillary Silva International Business b) If the demand for petrol were more elastic, would this tax be more effective or less effective in reducing the quantity of petrol consumed? Explain with both words and a diagram. If it were more elastic the tax would be more effective. A market with a more elastic demand would be more affected by a change in the price. c) Are consumers of petrol helped or hurt by this tax? Why? They are hurt because they get lower quantity at a higher price. d) Are workers in the oil industry helped or hurt by this tax? Why? The price received by producers is lower so their wages may be reduced and they could even lose their jobs because the quantity produced is also lower.ç Hillary Silva International Business 5. A case study discusses the minimum wage law: a) Suppose the minimum wage is above the equilibrium wage in the market for unskilled labour. Using a supply and demand diagram of the market for unskilled labour, show the market wage, the number of workers who are employed and the number of workers who are unemployed. Also show the total wage payments to unskilled workers. b) Now suppose the minister for employment proposes an increase in the minimum wage. What effect would this increase have on employment? Does the change in employment depend on the elasticity of demand, the elasticity of supply, both elasticities, or neither? The effect would be a decrease in employment. The more elastic the demand curve is the greater will be the decline in employment. c) What effect would this increase in the minimum wage have on unemployment? Does the change in unemployment depend on the elasticity of demand, the elasticity of supply, both elasticities, or neither? The increase in the minimum wage will increase unemployment. Both supply and demand elasticities affect unemployment: the more elastic both curves are, the larger the increase in unemployment. d) If the demand for unskilled labour were inelastic, would the proposed increase in the minimum wage raise or lower total wage payments to unskilled workers? Would your answer change if the demand for unskilled labour were elastic? If demand for unskilled labor were inelastic, then the increase would increase total wage payments. If demand for unskilled labor were elastic, total wage payments would decrease. Hillary Silva International Business 6. After your economics lecture one day, your friend suggests that taxing food would be a good way to raise revenue because the demand for food is quite inelastic. In what sense is taxing food a 'good' way to raise revenue? In what sense is it not a 'good' way to raise revenue? Taxing food may be a good way to raise revenue because the demand curve for food is very inelastic just because everybody has to buy food to eat. Therefore, if the price increases people would not be able to find close substitutes and they will buy food, what would result in an increase of revenues. But in the other hand, taxing food is not good because eating is a basic necessity and it’s already too much difficult for some people to obtain it, so rising the price would be cruel. All families’ purchasing power would decline, and that would make decrease the demand for the rest of the goods too, so other markets in the country would be worse off. 7. A subsidy is the opposite of a tax. With a € 0.5 0 tax on the buyers of ice cream cornets, the government collects € 0.50 for each cornet purchased;; with a € 0.50 subsidy for the buyers of ice cream cornets, the government pays buyers € 0.50 for each cornet purchased. a) Show the effect of a € 0.50 per cornet subsidy on the demand curve for ice cream cornets, the effective price paid by consumers, the effective price received by sellers and the quantity of cornets sold. Before subsidiaris After subsidiaris PS= E+H PS=C+D+R+H CS= A+C CS=A+C+E+F+I TS= E+H+A+C TS=A+C+D+E+F+H+I GE=C+D+E+F+G+G+I DWL=G The effective price paid by the consumers is reduced by €0.25. (Pcon) The effective price received by sellers increase by €0.25. (Pprod) The quantity of cornets sold increase. (Q’) Hillary Silva International Business b) Do consumers gain or lose from this policy? Do producers gain or lose? Does the government gain or lose? Consumers gain and producers gain too, as we see in the surpluses. The government has to pay the difference between the buyers and sellers price, so loses money, but gains in activating the economy. c) Does a subsidy lead to a deadweight loss? Explain. Yes, a subsidy leads to a deadweight loss. As we see the area G is the deadweight loss. Because there are resources that are not efficacy and effectively used. Because the quantity of the resources used is higher than the optimum one, so some expenses of the government are the deadweight loss, that are assumed by the same government. 8. Give an example of a positive production externality and an example of a negative production externality. And give an example of a positive consumption externality and an example of a negative consumption externality. (Different from the ones we have seen in class or in the textbook). A positive production externality could be the rehabilitation of a ruined neighbourhood by a construction company that start building houses there. A negative production externality could be the nuclear energy that produces lots of electricity but it also generates radioactive wastes that will be suffered by future generations. A positive consumption externality could be buying products sold by NGOs that use their benefits helping needy people. A negative consumption externality could be smoking, because it damages the people around that don’t want to smoke. Another example could be driving a car that does a lot of noise which could disturb other people. 9. There are at least three negative externalities associated with driving. a) Which are these externalities? Does this explain why petrol is taxed so heavily? 1. Congestion: too many cars on the road cause traffic. By taxing petrol, less people drive and use other types of transport, so the traffic decreases. 2. Accidents: people driving large cars (such as 4x4) put the rest of the people driving typical cars in risk, because in an accident, people driving typical cars can die due to the size and power of the large car. The petrol tax is and indirect way of making people pay when they large. 3. Pollution: carbon emission increases by fuel burning, so a tax on petrol reduce the quantity consumed of it, that is, less emission of toxic gas Hillary Silva International Business b) Illustrate the market for petrol, labelling the demand curve, the social value curve, the supply curve, the social cost curve, the market equilibrium level of output and the efficient level of output. c) On your graph, shade the area corresponding to the deadweight loss of the market equilibrium and explain the intuition behind it. The optimum quantity is below the equilibrium quantity, so it results as the deadweight loss, which can be seen in the previous graph as the red area. Hillary Silva International Business 10. Consider the market for fire extinguishers. a) Why might fire extinguishers exhibit positive externalities? Because they may prevent fire from damaging others’ property, even though people buy them for their own use. b) Draw a graph of the market for fire extinguishers, labelling the demand curve, the social value curve, the supply curve and the social cost curve. c) Indicate the market equilibrium level of output and the efficient level of output. Give an intuitive explanation for why these quantities differ. Buyers do not take external benefits into consideration when purchasing a fire extinguisher. d) If the external benefit is €10 per extinguisher, describe a government policy that would result in the efficient outcome. Provide a subsidy of 10€ per fire extinguisher to buyers. 11. Do you agree with the following statements? Why or why not? a) 'The benefits of Pigovian taxes as a way to reduce pollution have to be weighed against the deadweight losses that these taxes cause.' In fact, Pigovian taxes reduce the inefficiency of pollution by reducing the quantity of the good being produced that as pollution as a by-product. So, Pigovian taxes reduce deadweight loss, they do not increase it. Hillary Silva International Business b) 'When deciding whether to levy a Pigovian tax on consumers or producers, the government should be careful to levy the tax on the side of the market generating the externality.' It does not matter in whom the tax is imposed, the incidence of the tax will be identical. So whether the externality is caused by the seller or the buyer of the good, a tax on either producers or consumers will lead to the same reduction of quantity and change in the prices producers receive or consumers pay. 12. What is the Coase theorem? Suppose that collectively, the 1000 residents of Green Valley value swimming in Blue Lake at 100,000€. A nearby factory pollutes the lake water, and would have to pay 50,000€ for non-polluting equipment. is a legal and economic theory that affirms that where there are complete competitive markets with no transactions costs, an efficient set of inputs and outputs to and from production-optimal distribution are selected, regardless of how property rights are divided. a) Describe a Coase-like private solution. - b) Can you think of any reasons why this solution might not work in the real world? - 14. What kind of good is a road? Is it excludable? Is it rival in consumption? (Hint: the answer depends on whether the road is congested or not, and whether it is a toll road or not. Consider the different cases.) A road can be whether public or private. When it is a national road, which belongs to the state, is public, not excludable and depending on the situation can be rival in consumption. For example when there is a traffic jam, however it is often not rival in consumption. Another case is when the highway belongs to a company, then it is private and excludable because maybe, some people cannot afford to pay the tax they charge so they cannot enter to the road. Finally, they are rival in consumption. 15. Both public goods and common resources involve externalities. a) Are the externalities associated with public goods generally positive or negative? Use examples in your answer. Is the free market quantity of public goods generally greater or less than the efficient quantity? Public goods produce positive externalities. The free-market quantity of public goods is less than the efficient quantity. A fireworks display is a public good because it is non-excludable (impossible to prevent people from using it) and non-rivalrous (one individual's use does not reduce availability to others). Because public goods are not excludable, the free-market quantity is zero, so itis less than the efficient quantity. Hillary Silva International Business b) Are the externalities associated with common resources generally positive or negative? Use examples in your answer. Is the free market use of common resources generally greater or less than the efficient use? The externalities associated with common resources are generally negative. Because common resources are rival in consumption but not excludable, the use of the common resources by one person reduces the amount available for others. Because common resources are not priced, people tend to over use them ¾ their private cost of using the resources is less than the social cost. Examples include fish in the ocean, the environment, congested non toll roads, the Town Commons, and congested parks. 16. What is a free-rider? What does it have to do with public goods and common resources? Goods differ in whether they are excludable and whether they are rival. A good is excludable if it is possible to prevent someone from using it. A good is rival if one person’s enjoyment of the good prevents other people from enjoying the same unit of the good. Markets work best for private goods, which are both excludable and rival. Markets do not work as well for other types of goods. Common resources are rival but not excludable. Examples include common grazing land and clean air. Because people are not charged for their use of common resources, they tend to use them excessively. Therefore, governments try to limit the use of common resources. Public goods are neither rival nor excludable. So, people cannot be prevented from using a public good, and one person’s enjoyment of a public good does not reduce another person’s enjoyment of it. Examples of public goods include fireworks displays and national defense. To understand how public goods differ from other goods and what problems they present for society. Private markets will usually u...
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- Winter '15
- Hillary Silva, International Business, consumer surplus, producer surplus