Answer Key to the Second exam- Econ 200-W13

Answer Key to the Second exam- Econ 200-W13 - Second...

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Second Exam-Econ 200B Winter 2013 90 points- Maximum of 1 hour and 15 minutes allowed Answer key 1. (24 points) The U.S. government maintains price supports on both rice and wheat, i.e., the government maintains a price for each of these grains above what would otherwise exist with a free market. a. (5 points) Explain, with a diagram, why we have surpluses in these grains. The price is set too high and is not allowed to come down. At the price of $4 per unit, suppliers produce 160 units while the buyers only purchase 60 unit. Hence a surplus results. b. (19 points) Suppose the price floor for wheat was abandoned, so there was a free market in wheat, but the price support was maintained for rice. Explain the effects of this on the markets for both wheat and rice. Use supply and demand graphs to accompany your written analysis. In the wheat market price drops to equilibrium and quantity purchased will rise. Since wheat and corn are substitutes in demand, with a lower price (and greater quantity) of wheat, the demand for corn will shift to the left, increasing the surplus of corn . [There is of course a bit more to the story: since some wheat land will now be freed up and some will go into rice production, this will shift the supply curve of rice to the right. This also increases the surplus of rice. Another possible supply effect: in the wheat 1
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market as farmers switch to rice farming the supply of wheat will fall, increasing the price of wheat. This part is not required to receive full points.] 2. (17 points) The state of Washington would like to raise more tax revenues. They consider an increase in property tax on view properties (properties with lake or ocean view), and, extending the sales tax to food. a. Explain who will pay most of the new taxes in each case. Use a supply and demand diagram in each case and consider the effect of taxation on suppliers of view property, and also tax imposed on the consumers of food. Use the graphs to explain --in a short paragraph-- who will likely pay most (or all) of the tax in each case and why. [Please note the relative elasticity of supply of view property compared to the elasticity of supply of food. There are a fixed number of view properties with lake or ocean view.] (12 points) Since the supply of view property is limited (quantity is fixed), we can consider the supply curve perfectly inelastic. The tax on the supplier of the property will not change the price of the property in the market. However, the owner would have to send in the tax to the government. Therefore the property supplier pays all of the tax (or most of the tax if supply is considered relatively inelastic). The height from the red line in the graph shows the after tax price of property view per period (imputed property rent). Since the supply of food is perfectly elastic (as we discussed in our class session, the supply of food is perfectly elastic here, but it is OK to do a clearly relatively elastic supply for food. If the analysis is correct and consistent with this assumption, this answer receives full points). In this case, the
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