Question for review 4

Question for review 4 - Ques%ons for review IV Ch 9...

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Unformatted text preview: Ques%ons for review IV Ch 9 What is meant by deadweight loss? Why does a price ceiling usually result in a deadweight loss? •  Deadweight loss refers to the benefits lost by consumers and/or producers when markets do not operate efficiently. The term deadweight denotes that these are benefits unavailable to any party. A price ceiling set below the equilibrium price in a perfectly compe%%ve market will result in a deadweight loss because it reduces the quan%ty supplied by producers. Both producers and consumers lose surplus because less of the good is produced and consumed. The reduced (ceiling) price benefits consumers but hurts producers, so there is a transfer from one group to the other. The real culprit, then, and the primary source of the deadweight loss, is the reduc%on in the amount of the good in the market. How can a price ceiling make consumers be9er off? Under what condi<ons might it make them worse off? •  If the supply curve is highly inelas%c a price ceiling will usually increase consumer surplus because the quan%ty available will not decline much, but consumers get to purchase the product at a reduced price. If the demand curve is inelas%c, on the other hand, price controls may result in a net loss of consumer surplus because consumers who value the good highly are unable to purchase as much as they would like. (See Figure 9.3 on page 313 in the text.) The loss of consumer surplus is greater than the transfer of producer surplus to consumers. So consumers are made beOer off when demand is rela%vely elas%c and supply is rela%vely inelas%c, and they are made worse off when the opposite is true. •  In a compe%%ve market, the following supply and demand equa%ons are given: Supply P = 5 + 0.36Q Demand P = 100  ­ 0.04Q, where P represents price per unit in dollars, and Q represents rate of sales in units per year. •  a. Determine the equilibrium price and sales rate. •  b. Determine the deadweight loss that would result if the government were to impose a price ceiling of 40 dollars per unit. •  Answer: •  a. Equate supply and demand to get equilibrium values. •  5 + 0.036Q = 100  ­ 0.04Q •  0.076Q = 95 •  Q = 1,250 units per year •  The equilibrium price is •  P = 5 + 0.036(1250) = $50.00 per unit. •  b. With a price ceiling of $40, the deadweight loss is the triangle between supply and demand bounded by Q of 1250 and the new sales rate at P of 40. •  •  •  •  •  Rearrange supply in terms of P. P = 5 + 0.036Q or Q =  ­138.89 + 27.78P At P = 40, Q =  ­138.89 + 27.78(40) Q' = 972.31 units per year. The base of the triangle (rotated 90 degrees) is the ver%cal distance between the heights of supply and demand when Q = 972.31 •  Height of demand = P = 100  ­ 0.04(972.31) = 61.11 •  Height of supply = P = 5 + 0.036(972.31) = 40.00 •  Triangle base is the difference = 21.11 •  Height of triangle = Q  ­ Q' = 1250  ­ 972.31 = 277.69 •  Deadweight loss = 1/2 b  h = (1/2)(21.11)(277.69) = $2,931. •  ...
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