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Unformatted text preview: widgets being an inferior good), it must be true that price goes down (unless the supply curve is perfectly elastic, but in this case, we are given that price goes up so we know supply cannot be perfectly elastic). This also tells us that the supply curve is perfectly inelastic, because that’s the only way that quantity won’t change. See the diagram on the next page. So, the answer is E. S P1 P D1 D Q=Q1 10. The first thing would be to draw the market that we have in the question. We want to draw demand “normally” like how we do since it is unit elastic, and then we want to draw supply as a horizontal line since it is perfectly elastic. With cases like this, it always helps to just draw a normal supply and demand diagram and see how the tax wedge is drawn. If you do that, you will realize that we want to draw a wedge from the demand curve DOWN to the supply curve. So let’s see how we can do that here: P D S P*=Ps D Qtax
Q* So we see that in this industry, a tax will only cause the price that consumers have to pay to go up, which makes sense since supply is perfectly elastic – which means that it is completely sensitive to price changes. If the price increases by even just a bit, they will not produce. So, the consumers bear the entire burden of tax and equilibrium quantity decreases because of the tax. The answer is A. 11. This is a violation of "efficient production", i.e. the rule that the most efficient (i.e. least costly) producers should produce. If five widgets are to be produced, the five most efficient producers are S1‐S5, not S2‐S6. Thus, S1 should produce instead of S6. Any deal between S1 and S6 such that S1 willingly produce a widget and S6 willingly give up the production of a widget is a Pareto improvement. The answer is E. 12. A price floor of $7 gives a quantity demanded (Qd) of 3 units and quantity supplied (Qs) of 7 units. Among the buyers, only D1‐D3 are willing to pay a widget for $7 (or above), thus we are certain that they are the buyers. Hence option (1) is certainly true. However, among the producers, S1‐S7 are willing to produce and sell a widget at $7. Since only three widgets will be transacted (because there are only three buyers), the production of three widgets among seven willing producers will have to be rationed. No such rationing rule is mentioned in the question, thus option (5) is true, instead of option (3) or (4). The answer is D. Variable $8 Tax Change Q 5 1...
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- Spring '07