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Econ 101 Winter 2010 Problem Set 5

Econ 101 Winter 2010 Problem Set 5 - Economics 101...

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Problem Set 5 February 11 & 12 University of Michigan Winter 2010 Economics 101 Microeconomics
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Econ 101.400 Winter 2010 Question One Analyzing the effects of government subsidies is much the same as analyzing the effects of taxation. In the case of taxation, two distinct prices exist in the market: the consumer and the producer price. The price that consumers pay is greater than the price the producer pays by the amount of the tax. In the case of a production subsidy, a similar situation arises. We can consider two distinct prices in the market: a consumer price and a producer price. The price paid by consumers, however, is less than the price received by producers by the amount of the subsidy. To see this, suppose that the consumer pays P c for a unit of the subsidized good. Then the producer receives that payment of P c plus the government subsidy (call this s). The total price received by the producer is P p = P c + s. (a) Draw a diagram with supply and demand curves. Identify the free-market competitive equilibrium price and quantity. Now suppose that production of this good is subsidized by $s/unit. Depict the new equilibrium in your diagram. This requires the two prices be identified: the producer and consumer prices.
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