13-Discussion Questions - Solutions

13-Discussion Questions - Solutions - Lecture 13: Perfect...

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Lecture 13: Perfect Competition (III) Suggested questions and exercises (Pindyck and Rubinfeld, Ch.9). Questions: 1, 2, 8, 10 Exercises: 4, 6, 8 QUESTIONS 3. How can a price ceiling make consumers better off? Under what conditions might it make them worse off? If the supply curve is perfectly inelastic a price ceiling will increase consumer surplus. If the demand curve is inelastic, price controls may result in a net loss of consumer surplus because consumers willing to pay a higher price are unable to purchase the price-controlled good or service. The loss of consumer surplus is greater than the transfer of producer surplus to consumers. If demand is elastic (and supply is relatively inelastic) consumers in the aggregate will enjoy an increase in consumer surplus. 8. The burden of a tax is shared by producers and consumers. Under what conditions will consumers pay most of the tax? Under what conditions will producers pay most of it? What determines the share of a subsidy that benefits consumers? The burden of a tax and the benefits of a subsidy depend on the elasticities of demand and supply. If the ratio of the elasticity of demand to the elasticity of supply is small, the burden of the tax falls mainly on consumers. On the other hand, if the ratio of the elasticity of demand to the elasticity of supply is large, the burden of the tax falls mainly on producers. Similarly, the benefit of a subsidy accrues mostly to consumers (producers) if the ratio of the elasticity of demand to the elasticity of supply is small (large). 9. Why does a tax create a deadweight loss? What determines the size of this loss? A tax creates deadweight loss by artificially increasing price above the free market level, thus reducing the equilibrium quantity. This reduction in demand reduces consumer as well as producer surplus. The size of the deadweight loss depends on the elasticities of supply and demand. As the elasticity of demand increases and the elasticity of supply decreases, i.e., as supply becomes more inelastic, the deadweight loss becomes larger. EXERCISES 1. In 1996, the U.S. Congress raised the minimum wage from $4.25 per hour to $5.15 per hour. Some people suggested that a government subsidy could help employers finance the higher wage. This exercise examines the economics of a minimum wage and wage subsidies. Suppose the supply of low-skilled labor is given by L w S = 10 , where L S is the quantity of low-skilled labor (in millions of persons employed each year) and w is the wage rate (in dollars per hour). The demand for labor is given by L w D = 80 - 10 .
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a. What will the free market wage rate and employment level be? Suppose the
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This note was uploaded on 11/30/2010 for the course ECON 251 taught by Professor Tontz during the Fall '10 term at USC.

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13-Discussion Questions - Solutions - Lecture 13: Perfect...

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