301ans4 - Professor S Severinov Economics 301 UBC Spring...

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Professor S. Severinov Economics 301, UBC Spring 2010 Problem Set 4 Answer Key 1) When the supply curve is completely inelastic, it is vertical. In this case there is no deadweight loss because there is no reduction in the amount of the good produced. The imposition of the price ceiling transfers all lost producer surplus to consumers. Consumer surplus increases by the difference between the market-clearing price and the price ceiling times the market-clearing quantity. Consumers capture all decreases in total revenue, and no deadweight loss occurs. 2) Municipal authorities usually regulate the number of taxis through the issuance of licenses or medallions. When the number of taxis is less than it would be without regulation, those taxis in the market may charge a higher- than-competitive price. State authorities usually regulate the number of liquor licenses. By requiring that any bar or restaurant that serves alcohol have a liquor license and then limiting the number of licenses available, the state limits entry by new bars and restaurants. This limitation allows those establishments that have a license to charge a higher-than-competitive price for alcoholic beverages. Federal authorities usually regulate the number of acres of wheat or corn in production by creating acreage limitation programs that give farmers financial incentives to leave some of their acreage idle. This reduces supply, driving up the price of wheat or corn. 3) The burden of a tax and the benefits of a subsidy depend on the elasticities of demand and supply. If the absolute value of the ratio of the elasticity of demand to the elasticity of supply is small, the burden of the tax
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falls mainly on consumers. If the ratio 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) in absolute value. 4) a) If there is no tariff then consumers will pay $10 per pound of coffee, which is found by adding the $8 that it costs to import the coffee plus the $2 that it costs to distribute the coffee in the U.S. In a competitive market, price is equal to marginal cost. At a price of $10, the quantity demanded is 150 million pounds. b) Now add $2 per pound tariff to marginal cost, so price will be $12 per pound, and quantity demanded is Q = 250 – 10(12) = 130 million pounds. c) Lost consumer surplus is (12–10)(130) + 0.5(12–10)(150–130) = $280 million. d) There is a net loss to society because the gain ($260 million) is less than the loss ($280 million). 5) a) With a $9 tariff, the price of the imported metal on U.S. markets would be $18, the tariff plus the world price of $9. The $18 price, however, is above the domestic equilibrium price. To determine the domestic equilibrium price, equate domestic supply and domestic demand: 2 3 P = 40 – 2 P , or P = $15.
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