How does a price control impact the process of a price adjustment to equilibrium?
Does a price ceiling set below equilibrium price force a shortage or a surplus to persist in the market?
Does a price floor set above equilibrium price force a shortage or a surplus to persist in the market?
How does a price ceiling set above equilibrium price impact the market? Explain.
How does a price floor set below equilibrium price impact the market? Explain.
Consider a perfectly competitive market with demand curve given by \(Q_D = 100 - 2P\) and supply curve given by \(Q_S = 50 + 3P\text{.}\)
Find equilibrium \((P^*, Q^*)\) in the market. Show this in a graph.
Suppose a price ceiling of \(P_C = 8\) is introduced in the market. What is quantity demanded at this price? Quantity supplied?
What is the quantity exchanged in the market? What is the size of the shortage or surplus if there is one? Label this new price and quantity on a graph, along with the size of the shortage or surplus.
Consider a perfectly competitive market with demand curve given by \(Q_D = 100 - 2P\) and supply curve given by \(Q_S = 50 + 3P\text{.}\)
At a price of 20, what is \(Q_D\text{?}\) What is \(Q_S\text{?}\) Does the market clear? If not, is there a shortage or a surplus? Illustrate this on a graph of supply and demand.
At a price of 5, what is \(Q_D\text{?}\) What is \(Q_S\text{?}\) Does the market clear? If not, is there a shortage or a surplus? Illustrate this on a graph of supply and demand.
At what price does the market clear? Solve for the equilibrium price and quantity, \(P^*\) and \(Q^*\text{.}\) Illustrate this on a graph of supply and demand. Consider equilibrium \((P^*, Q^*)\) in the market from the problem above, with demand curve given by \(Q_D = 100 - 2P\) and supply curve given by \(Q_S = 50 + 3P\text{.}\) Examine what happens when there is a supply increase such that the new supply curve in the market is given by \(Q_S' = 60 + 3P\text{.}\)
Is the market still in equilibrium at the price \(P^*\text{?}\) Show this numerically and with a graph.
If there is a new equilibrium with the new supply curve, call it \((P^{**}, Q^{**})\) and find it. What does this show about the impact of an increase in supply on equilibrium price and quantity?
Consider a perfectly competitive market for milk (where 1Q = 100 gallons), with demand curve given by \(Q_D = 200 - 2P\) and supply curve given by \(Q_S = 2P\text{.}\)
Find the equilibrium price and quantity of milk exchanged, using the supply function and demand function given above.
Draw this equilibrium very carefully, and label each axis; equilibrium price and quantity; consumer surplus; producer surplus; and deadweight loss (if it exists).
Calculate the value for consumer surplus, producer surplus, and deadweight loss.\ Now the government implements a price floor regulation: the price per unit cannot be below $60.
Find the new price and quantity of milk exchanged in the market under the price floor.
Demonstrate the effects of the law by drawing (on a new graph) and calculating consumer surplus, producer surplus, and deadweight loss.
Even though market transactions are legally prohibited, what if human kidneys could be exchanged in a perfectly competitive market? Let the supply of kidneys in the market be given by \(Q_S = 80 + 4P\text{,}\) so even at a price of zero, 80 kidneys are supplied to the market. Demand for kidneys (representing patients in need of a transplant) is given by \(Q_D = 160 - 4P\text{.}\)
Find the equilibrium price and quantity of kidneys exchanged if market exchanges are legal, using the supply function and demand function given above.
Draw this equilibrium very carefully, and label each axis; equilibrium price and quantity; consumer surplus; producer surplus; and deadweight loss (if it exists).
Calculate the value for consumer surplus, producer surplus, and deadweight loss.\ Now the government makes the practice of buying and selling kidneys illegal. However, kidneys can still be exchanged via free donation, as long as individuals are willing to supply them. (One way to interpret this is that the market price cannot exceed zero.)
Provided those consumers with the highest willingness to pay are also those consumers highest on the transplant list, where is the new equilibrium price and quantity?
Is the law efficient? Demonstrate the effects of the law by drawing (on a new graph) and calculating consumer surplus, producer surplus, and deadweight loss.
Subsection6.5.2Taxes and subsidies
How does an excise (or per-unit tax) function? Describe in words.
In the presence of an excise tax, does the price consumers pay (\(P_C\)) equal the price sellers receive (\(P_S\))? Explain why or why not.
In the presence of an excise tax, which is higher? \(P_C\) or \(P_S\text{?}\) Explain.
How does a per-unit subsidy function? Describe in words.
In the presence of a per-unit subsidy, does the price consumers pay (\(P_C\)) equal the price sellers receive (\(P_S\))? Explain why or why not.
In the presence of a per-unit subsidy, which is higher? \(P_C\) or \(P_S\text{?}\) Explain.
If the government implements a new excise tax of $3 per unit on packs of cigarettes, does this mean consumers will pay $3 more for each pack of cigarettes? Explain. If you can, use a graph to support your argument!
How does an excise tax influence the quantity of units exchanged at the market outcome? How does this influence the efficiency of the market under the tax?
How does a per-unit subsidy influence the quantity of units exchanged at the market outcome? How does this influence the efficiency of the market under the subsidy?
Draw a graph of a perfectly competitive market with an excise tax. Indicate (and clearly label) the price consumers pay (\(P_C\)), the price sellers receive (\(P_S\)), the quantity exchanged in the market, consumer surplus, producer surplus, tax revenue generated by the tax, and deadweight loss (if it exists).
Draw a graph of a perfectly competitive market with a per-unit subsidy. Indicate (and clearly label) the price consumers pay (\(P_C\)), the price sellers receive (\(P_S\)), the quantity exchanged in the market, consumer surplus, producer surplus, the total cost to the government of providing the subsidy, and deadweight loss (if it exists).
Subsection6.5.3Externalities
Give three examples of activities, goods, or services which generate positive externalities.
Give three examples of activities, goods, or services which generate negative externalities.
In general, how can marginal analysis help us understand the optimal quantity of an activity?
What is the difference between the private marginal benefit and the social marginal benefit of an activity? When are PMB and SMB identical? When do they differ?
What is the difference between the private marginal cost and the social marginal cost of an activity? When are PMC and SMC identical? When do they differ?
What familiar curve is represented by the private marginal benefit curve? Explain.
What familiar curve is represented by the private marginal cost curve? Explain.
Give the equation which defines the private outcome or market outcome in a market, denoted \(q^*_{PRIV}\text{.}\)
Give the equation which defines the socially optimum outcome in a market, denoted \(q^*_{SOC}\text{.}\)
In the presence of a positive externality, which is larger: the market outcome \(q^*_{PRIV}\) or the socially optimal outcome \(q^*_{SOC}\text{?}\) What does this tell you about how much of the activity occurs in the market relative to the amount of the activity that is best for society?
In the presence of a negative externality, which is larger: the market outcome \(q^*_{PRIV}\) or the socially optimal outcome \(q^*_{SOC}\text{?}\) What does this tell you about how much of the activity occurs in the market relative to the amount of the activity that is best for society?
Subsection6.5.4Policy prescriptions for externalities
In general, why does the market outcome not align with the social optimum in the presence of an externality? How does this relate to the phrase “internalize the externality”?
In the presence of a positive externality, what is the best policy prescription? Why does this policy work to address the externality? Explain in words.
In the presence of a negative externality, what is the best policy prescription? Why does this policy work to address the externality? Explain in words.
Draw a graph of a perfectly competitive market where the government addresses a positive externality. Indicate (and clearly label) the PMB, PMC, SMB, and SMC curves, the market outcome \(q^*_{PRIV}\text{,}\) the social optimum \(q^*_{SOC}\text{.}\) Also include the size of the per-unit subsidy, the price consumers pay \(P_C\text{,}\) the price sellers receive \(P_S\text{,}\) the total cost to the government of implementing the subsidy, and the total number of units exchanged after the subsidy is in place.
Draw a graph of a perfectly competitive market where the government addresses a negative externality. Indicate (and clearly label) the PMB, PMC, SMB, and SMC curves, the market outcome \(q^*_{PRIV}\text{,}\) the social optimum \(q^*_{SOC}\text{.}\) Also include the size of the excise tax, the price consumers pay \(P_C\text{,}\) the price sellers receive \(P_S\text{,}\) the revenue generated by the excise tax, and the total number of units exchanged after the tax is in place.
Consider a perfectly competitive market for flu shots, a good which generates an externality. The private marginal cost is given by \(PMC = 3q\text{.}\) The private marginal benefit curve is given by \(PMB = 100 - 2q\text{.}\)
What is the social marginal cost curve SMC? How do you know? Explain.
Find the market outcome, \(q^*_{PRIV}\text{.}\)
If the social marginal benefit curve is given by \(SMB = 120 - 2q\text{,}\) find the social optimum, \(q^*_{SOC}\text{.}\)
Graph this situation (including all 4 curves). How does it compare to \(q^*_{PRIV}\) and what does this say about the nature (positive/negative) and size of the externality?
What policy would you use to address this externality? How large does the policy have to be to move the market to the social optimum?
If the social marginal benefit curve is given by \(SMB = 120 - q\text{,}\) find the social optimum, \(q^*_{SOC}\text{.}\) Graph this situation (including all 4 curves). How does it compare to \(q^*_{PRIV}\) and what does this say about the size of the externality that is different from part e.)?
Consider the market for flu shots in Tacoma. As there are many providers of flu shots, many consumers who want to purchase flu shots during flu season, and considering that all flu shots are identical, we will model the market using perfect competition. The demand function in the market is given by \(Q_D = 500 - 5P\text{.}\) The supply function in the market is given by \(Q_S = 15P\text{.}\)
Find the equilibrium price of a flu shot (\(P^*\)) and the equilibrium quantity of flu shots (\(Q^*\)) in the market. In a graph with carefully-labeled curves and axes, draw the demand and supply functions, and equilibrium (labeled).
On your graph from a., label consumer surplus and producer surplus. Calculate their values.
Flu shots likely have an additional impact on society at large. What kind of externality is generated in the market? What kind of per-unit policy should the city of Tacoma implement and why? (Explain in words.)
Suppose the city aims to increase the quantity of flu shots traded in the market to 500. What is the price consumers would have to pay (\(P_c\)) to achieve it? What is the price sellers would have to receive (\(P_s\)) to achieve it? Show algebraically. (Hint: these prices and quantities may not be round numbers!)
Given these values, what is the size of the policy per flu shot? Interpret the size of the policy in terms of the externality.
Draw a new carefully-labeled graph, with supply and demand functions, and the policy. Calculate the new consumer surplus, the new producer surplus, and the cost of this policy.
