Week3.DemandandUtility.2007

# Week3.DemandandUtility.2007 - Week#3 Demand and Utility...

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Week #3 – Demand and Utility Review from last week: What will happen to the equilibrium price and the equilibrium quantity traded of coffee (a normal good) if (a) consumer incomes increase, and (b) a technological improvement in coffee production lowers costs at the same time? Quantity of coffee per month S 0 D 0 Price

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What will happen to the equilibrium price and the equilibrium quantity traded of coffee (a normal good) if (a) consumer incomes increase, and (b) the price of tea (a substitute) falls at the same time? Quantity of coffee per month S 0 D 0 Price
What will happen to the equilibrium price and the equilibrium quantity traded of coffee if (a) wages rise on coffee plantations, and (b) the price of coffee whitener (a complement) falls at the same time? Quantity of coffee per month S 0 D 0 Price

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Q: The market for tomatoes in Toronto is perfectly competitive. Demand is given by P = 100 – Q and Supply is given by P = 10 + 0.5Q. The initial equilibrium price and quantity is P 0 * = \$40 and Q 0 * = 60 (where Q is measured in bushels per month). In order to help tomato farmers who are suffering from unstable incomes, the government decides to pass legislation enforcing a price floor of \$60 per bushel. Who will be helped and who will be hurt by this legislation? Is it likely that some farmers will try to sell tomatoes at prices below the price floor? A: At a price floor of \$60, quantity demanded will be 60 = 100 – Q, so Q D = 40. Quantity supplied will be 60 = 10 + 0.5Q, so Q S = 100. There is excess supply of 100 - 40 = 60 units. Assuming that only 40 units are traded (the lesser of quantity supplied and quantity demanded), the farmers who supply these 40 units of tomatoes will be better off (selling at a higher price). However, the other 60 units of
tomatoes cannot be sold, and the suppliers of these units are worse off. Consumers are worse off in two ways. Those who get to consume the 40 bushels of tomatoes have to pay a higher price. And those who used to consume the other 20 units of tomatoes (in perfectly competitive equilibrium) have been squeezed out of the market by the higher price. Some farmers are likely to try to sell tomatoes at prices lower than the legislated price floor. At 40 units of tomatoes, the marginal supplier would be willing to supply tomatoes for P = 10 + 0.5(40) = \$30 per bushel. In other words, this supplier can cover his/her marginal costs of producing tomatoes at a \$30 price. Since consumers are likely to be willing to buy tomatoes at this price a “gray” market in tomatoes may form.

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Week3.DemandandUtility.2007 - Week#3 Demand and Utility...

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