Problem Set #3

ECON 211
Due Wednesday, March 4, 2026 at the beginning of class.

1. The government has decided that the market price of cheese is too low.
(a) Suppose the government imposes a binding price floor in the cheese market. Draw a supply and
demand graph to show the effect of this policy on the price of cheese and the quantity of cheese
sold. Is there a shortage or surplus of cheese?
(b) Farmers complain that they are hurt by the price floor. Is this possible? Explain (think about
which farmers might be hurt).
(c) In response to farmers’ complaints, the government agrees to purchase all the surplus cheese at the
price floor. Compared to the basic price floor, who benefits from this new policy? Are taxpayers
winners?
2. Suppose the federal government requires root beer drinkers to pay a $2 tax on each case of root beer
purchased.
(a) Draw a supply and demand graph of the market for root beer without the tax. Show the price
paid by consumers, the price received by producers, and the quantity of root beer sold. What is
the difference between the price paid by consumers and the price received by producers?
(b) Now draw a supply and demand diagram for the root beer market with the tax. Show the price
paid by consumers, the price received by producers, and the quantity of beer sold. What is the
difference between the price paid by consumers and the price received by producers? Has the
quantity of root beer sold increased or decreased?
3. Congress and the president decide that the United States should reduce air pollution by reducing its
use of gasoline. They impose a $0.50 tax for each gallon of gasoline sold.
(a) Should they impose this tax on producers or consumers? Explain carefully using a supply and
demand graph.
(b) If the demand for gasoline were more elastic, would this tax be more effective or less effective in
reducing the quantity of gasoline consumed? Explain with both words and a diagram.
(c) Are consumers of gasoline helped or hurt by this tax? Why?
(d) Are workers in the oil industry helped or hurt by this tax? Why?
4. Melissa buys an iPad for $120 and gets consumer surplus of $80.
(a) What is her willingness to pay?
(b) If she had bought the iPad on sale for $90, what would her consumer surplus have been?
(c) If the price of an iPad were $250, what would her consumer surplus have been? (be careful)
5. The market for pizza is a competitive market.
(a) Draw the competitive market for pizza in equilibrium. Label the price, quantity, consumer surplus,
and producer surplus. Is the market efficient?
(b) Suppose that the government forces each pizzeria to pay a $1 tax on each pizza sold. Illustrate
the effect of this tax on the pizza market, be sure to label the consumer surplus, producer surplus,
tax revenue, and deadweight loss. How does each area compare with the pre-tax case?
(c) If the tax were removed, pizza eaters and sellers would be better off, but the government would
lose tax revenue. Suppose that consumers and producers voluntarily transferred some of their
gains to the government. Could all parties (including the government) be better off than they
were with a tax? Explain using the labeled areas on your graph.

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6. Suppose the government currently raises $100 million through a 1-cent tax on widgets, and another
$100 million through a 10-cent tax on gadgets. If the government doubled the tax rate on widgets and
eliminated the tax on gadgets, would it raise more tax revenue than it does today, less tax revenue, or
the same amount? Explain.
7. Consider how health insurance affects the quantity of healthcare services performed. Suppose that the
typical medical procedure has a cost of $100, yet a person with health insurance pays only $20 out
of pocket. The person’s insurance company pays the remaining $80 (The insurance company recoups
the $80 through premiums, but the premium a person pays does not depend on how many procedures
that person chooses to undertake).

(a) Draw the demand curve in the market for medical care. (In your diagram, the horizontal axis
should represent the number of medical procedures.) Show the quantity of procedures demanded
if each procedure has a price of $100. (This is another way of saying that the supply curve is
going to be perfectly elastic).
(b) On your diagram, show the quantity of procedures demanded if consumers pay only $20 per
procedure. If the cost of each procedure to society is truly $100, and if individuals have health
insurance as just described, will the number of procedures performed maximize total surplus.
Explain.
(c) Economists often blame the health insurance system for excessive use of medical care (at least by
some people). Given your analysis, why might the use of care be viewed as “excessive”?
(d) What sort of policies might prevent this excessive use? (There are many possible answers)

8. Evaluate the following two statements: Do you agree? Why or why not?

(a) “A tax that has no deadweight loss cannot raise any revenue for the government.”
(b) “A tax that raises no revenue for the government cannot have any deadweight loss.”

9. [YOU DO NOT HAVE TO DO QUESTION 8.] We can use our tools of economics to learn
about the relationship between subsidies and lobbying. The U.S. government has many subsidies for
alternative energy development. A subsidy is like a reverse tax. For example, instead of increasing the
cost of producing (or purchasing) at each quantity, it decreases the cost of producing (or purchasing)
at each quantity. We’ll look at the market for windmills. Figure 1 below shows two graphs: one is
a case where the sellers of windmills have an elastic supply and the buyers of windmills (local power
companies) have inelastic demand. In the other case, the reverse is true.

Figure 1: Markets for Windmills

P P S

D
Q Q
(a) Graph 1 (b) Graph 2

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(a) Referring to Figure 1: In which case is supply more elastic than demand (Graph 1 or Graph 2)?
(b) In which case will a subsidy cut the price paid by the buyers the most: When demand is elastic
or when it is inelastic?
(c) In which case (Graph 1 or Graph 2) will a subsidy increase the price paid to the sellers the most:
When supply is elastic or when it is inelastic?
(d) Now look at how producer surplus and consumer surplus change in these two cases. To see this,
remember that producer surplus is the area above the supply curve and below the price, and
consumer surplus is the area below the demand curve and above the price. So in the first graph,
who gets the larger share of any subsidy-driven extra surplus: suppliers or demanders? Is that
the inelastic group or the elastic group?
(e) Now consider the second graph. Again, who gets the larger share of any subsidy-driven extra
surplus: suppliers or demanders? Is that the inelastic group or the elastic group?
(f) There’s going to be a pattern here in parts (d) and (e): The more [elastic or inelastic?] side of
the market gets most of the extra surplus from the subsidy.
(g) When Congress gives subsidies for the alternative energy market, it is hoping that a small subsidy
can get a big increase in output: In other words, they are hoping that the equilibrium quantity
will be elastic. At the same time, the groups most likely to lobby Congress for a big alternative
energy subsidy are going to be the groups that get the most extra surplus from any subsidy. After
all, if the subsidy doesn’t give them much surplus they’re not likely to ask Congress for it. So
here’s the big question: Will the groups that are most likely to lobby for a subsidy be the same
groups that are mostly likely to respond to the subsidy? (Note: This is a general lesson about
the incentives for lobbying: It’s not just a story about the alternative energy industry. And, for
the most part, alternative energy is a very good thing.)