Professor Jim Hornsten Problem Set #2

ECON 310-1: Microeconomic Theory Comparative Statics, Government Interventions

1. LUMBER. During the pandemic, many families incurred much lower commuting costs and were unable to take
vacations, so many spent their unexpectedly large incomes on home improvements. However, shipping challenges
impacted the supply of wood products. Suppose that the competitive market for lumber is described by market
supply, 𝑄 ! = 𝛽𝑃 , and market demand, 𝑄" = 40 − 2𝑃 + 2√𝑌, where Y is the level of income, 𝛽 a shipping shock,
P the price, and QS and Qd the quantities supplied and demanded.
#
a) If the level of income is 400 and 𝛽 = $, then find the price-elasticity of supply (PES) at the equilibrium price.
Also find the PES in equilibrium if 𝛽 is not specified (i.e., general).
b) Find the two reduced form equations that show how the equilibrium price (P*) depends on the level of income
and 𝛽 and how the equilibrium quantity (Q*) depends on income and 𝛽.
c) Find how P* and Q* change when the level of income (Y) and 𝛽 changes. In other words, find the four partial
%&∗ %&∗ %) ∗ %) ∗
derivatives - %' , %( , %' , %( /.

2. E-BIKES. Suppose that the equations PS = 10 + QS and Pd = 100 – 2Qd describe the inverse supply and
inverse demand in the market for e-bikes. Consider two different policies.
a) “These things are a curse! Inexperienced riders aren’t sure how to handle e-bikes yet often ride at dangerously
high speeds on quiet paths. A tax could discourage their use.” Suppose the City of Evanston wants to raise
reduce e-bike use, so it imposes a per-unit (excise) tax in this market. If the government levies a per-unit tax of
T, then how does the level of deadweight loss change as this per-unit tax increases? TIP: The per-unit tax
creates a wedge: T = Pd – PS.
b) “These things are a blessing! The environment would benefit if fewer Evanstonians drove cars, and an e-bike’s
pedal assist makes it easier for out-of-shape drivers to make the switch. A subsidy could encourage their use.”
If the government provides a per-unit subsidy of S, then how does the equilibrium level of consumer surplus
"*!
change as this per-unit subsidy increases? TIP: Compute "! .

3. LOS ANGELES RENTAL HOUSING. After the widespread damage from wildfires, demand and supply in the
competitive market for rental housing are described by Pd = 100 – Qd and PS = 10 + 2QS.
a) Find the competitive equilibrium price and quantity, P* and Q*, as well as CS, PS and Total Surplus.
b) In order to prevent “price gouging” in this market, suppose that a price ceiling of 30 is imposed on this market.
Find the size of the quantity shortage and decompose that into the amount due to “more buyers” and the amount
due to “fewer sellers.” TIP: Use the new quantities from S&D to find Qd – QS = (Qd – Q*) + (Q* – QS).
c) Suppose that the best case scenario occurs where deadweight loss is minimized because the most efficient
buyers (at the top left of the demand curve) get to buy. Draw the graph and find CS, PS, and DWL.
d) Suppose that the worst case scenario occurs where deadweight loss is maximized because the least efficient
buyers (at the bottom right of the demand curve) get to buy. Draw the graph and find CS, PS, and DWL.
4. TIMBER. Americans buy a lot of timber, and while some is produced in the U.S., much is imported from
Canada. In the U.S. market for timber, the demand function is Qd = 140 – Pd , where Qd is the quantity of timber
demanded domestically at a price of Pd. Domestic supply is given by QS = PS – 20 for prices PS ³ 20, and QS = 0
for PS < 20, where QS is the quantity of timber supplied domestically when domestic suppliers receive a price PS.
Foreign (e.g., Canadian) suppliers would be willing to supply any amount of timber at a world price of PW = 40.
TIP: You may find it easier to work with inverse S&D functions.
a) Compute the sum of domestic consumer surplus and domestic producer surplus when the U.S. government
imposes an import quota of 20 units of timber.
b) Instead of using a quota the government could protect domestic producers by using an import tariff. Suppose we
begin with an open economy and impose a per-unit import tariff, T. Assuming T remains low enough that the
U.S.. continues to import some timber, find the rate at which domestic producer surplus changes due to an
"&!
increase in the per-unit tariff, "+ .
c) Find the maximum amount of revenue the U.S. government could collect using a per-unit import tariff, T.

5. CORN PRICE SUPPORTS. In the perfectly competitive U.S. market for corn (a homogeneous good), inverse
demand is given by Pd = 60 – Qd , where Qd is the quantity of corn demanded at a price of Pd. Supply is given by
QS = PS, where QS is the quantity of corn supplied when suppliers receive a price PS. In this problem we will
analyze two different approaches that Congress could use to support corn farmers. Both approaches involve using
taxpayer dollars, which are collected and paid by the Treasury, which includes the tax-collecting IRS.
a) Find P* and Q*, the free market equilibrium price and quantity.
b) Suppose that corn farmers convince Congress to use an acreage limitation program to support a price (PMIN)
that is higher than P*. Find the total subsidy paid (by the Treasury) as a function of PMIN, and then the rate at
!"#$%&!'
which this changes when the minimum price is raised, HINTS: If you draw the graph, it may help you
!(𝑀𝐼𝑁
compute the desired area. Try a nice number first, and use it to find the area, then change it to PMIN. Remember
to use the chain rule!
c) Suppose instead that farmers convince Congress to use a government purchase program to buy up surplus
𝑑𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒
corn to support the above-equilibrium price, PMIN. Find , the rate at which the total amount paid (by
!("#$
the Treasury) to purchase surplus corn changes as the price increases above P*.
d) Draw and the compute the area of deadweight loss for each of the two policies.