Econ 281 Chapter 10 Posted Practice Problems Revised for Fall 2015 Scott Beesley

In these practice problems we are always starting from the same initial equilibrium, and then
imposing a constraint of some kind. Part A is the initial situation.

A. Demand curve is P = 100 – 0.02 Q Supply curve is P = 40 + 0.01 Q

Find the market equilibrium, including P, Q, Consumers’ Surplus, Producers’ Surplus, & Total
Surplus

B. Find the outcome when a tax of $12/unit is imposed. Calculate it as being imposed on or
collected by the buyer. Find Q, Pincl. tax , Pnet of tax, CS, PS, Tax collected, Total surplus, and the
deadweight loss vs. “A”.

C. Now assume a price ceiling is imposed at $50. Find the resulting outcome, including the
shortage amount. Then work out CS and PS and TS in two cases: Case I, the first year version
of the problem, in which the limited supply goes to those with the highest willingness to pay,
and Case II, in which the units go to those with the lowest WTP. In each of case I and II, find CS,
PS, TS, and the DWL relative to “A”. Which situation is more likely to occur in a real-world rent-
control example???

D. Work out the outcome for a price floor of $75. What is the percentage change in CS, PS and
TS?

E. Say the rest of the world, which is infinitely large relative to our little place, has a prevailing
market price of $80. Find the outcome when the border is opened up to trade (CS, PS, TS,
exports, domestic consumption, domestic production, and the gain from trade).

F. Now say the world price is $48. Find CS, PS, TS, and the gain from trade. Finally, assume
that a $6 per unit tariff is imposed – what is the DWL caused by the tariff?
Economics 281 Chapter 10 posted practice problems short answers Scott Beesley

A. P = 60 Q = 2,000 CS = 40,000 PS = 20,000 TS = 60,000

B. Qtax = 1,600 Pincl. tax = 68 Pnet-of-tax = 56 CS = 25,600 PS = 12,800

Tax $ Collected = 19,200 TS = 57,600 DWL of the tax = 2,400

C. QS (50) = 1,000 QD (50) = 2,500 shortage of 1,500 units PS = 5000 (in both cases)

Case I: CS = 40,000 TS = 45,000 DWLI = 15,000

Case II: CS = 10,000 TS = 15,000 DWLII = 45,000 Case II is more likely…

D. QS(75) = 3,500 QD(75) = 1,250 “Potential excess supply” = 2,250 Qactual = 1,250

CS = 15,625 (down 60.9%) PS = 35,937.50 (up 79.7%) TS = 51,562.50 (down 14.1%)

E. QS(80) = 4,000 QD(80) = 1,000 Exports = 3,000

CS = 10,000 PS = 80,000 TS = 90,000 Gain from trade = 30,000

F. QS(48) = 800 QD(48) = 2,600 Imports = 1,800

CS = 67,600 PS = 3,200 TS = 70,800 Gain from trade = 10,800

Now add the $6 tariff: Domestic P = PW + tariff = $54

QS(54) = 1,400 QD(54) = 2,300 Imports = 900 Tariff $ collected = 5,400

CS = 52,900 PS = 9,800 TS = 68,100

The gain from trade falls to 8,100 (from 10,800), so the DWLTariff = 2,700

(equivalently, TS falls from 70,800 to 68,100 when the tariff is imposed)

10.7. In a competitive market, there is currently no tax, and the equilibrium price is $40.
The market has an upward-sloping supply curve. The government is about to impose an
excise tax of $5 per unit. In the new equilibrium with the tax, what price will producers
receive and consumers pay if the demand curve is
a) Perfectly elastic
b) Perfectly inelastic
Illustrate your answers graphically.

a) With perfectly elastic demand, a $5 excise tax shifts the supply curve up as pictured
below. Producers will bear the entire burden of the tax. The end result is that the equilibrium
quantity falls from Q1 to Q2, the price consumers pay remains the same ($40), and the price
producers receive falls from $40 to $35.

P
S+ $5 S

$40 D

$35

Q2 Q1 Q

b) When demand is perfectly inelastic, consumers will bear the entire burden of the tax.
The $5 tax has no effect on the equilibrium quantity. However, the price consumers pay rises
from $40 to $45. The price producers receive remains constant at $40.

P D S+ $5
$45 S

$40

Q1 Q
10.10. Suppose that the market for cigarettes in a particular town has the following supply
and demand curves: QS = P; QD = 50 − P, where the quantities are measured in thousands
of units. Suppose that the town council needs to raise $300,000 in revenue and decides to do
this by taxing the cigarette market. What should the excise tax be in order to raise the
required amount of money?

Suppose that the required tax is $T. Then in equilibrium, P D  P S  T . This implies that
50  Q  Q  T , or Q = 25 – 0.5T. Since the required amount is $300,000, we must have T*Q =
300. (Remember that Q is measured in thousands of units). So, T(25 – 0.5T) = 300. Solving this
equation we get two possible values for the tax: T = $20 or T = $30. Either one would generate
$300,000 in tax revenues, though of course T = $20 would do so with a smaller deadweight loss.

(See the detailed answer on the next page…….)

 P
40

B C

I S
5 H
F E
J K L
2
G D
Q
70 120 175 190 200

70
10.18. In a perfectly competitive market, the market demand and market supply curves
are given by Qd = 1000 −10Pd and Qd = 30Ps. Suppose the government provides a subsidy of
$20 per unit to all sellers in the market.
a) Find the equilibrium quantity demanded and supplied; find the equilibrium market
price paid by buyers;
find the equilibrium after-subsidy price received by firms.
b) Find the consumer surplus and producer surplus in the absence of the subsidy. What is
the net economic benefit in the absence of a subsidy?
c) Find the consumer surplus and producer surplus in the presence of the subsidy. What is
the impact of the subsidy on the government budget? What is the net economic benefit
under the subsidy program?
d) Does the subsidy result in a deadweight loss? If so, how much is it?

In this case, the after-subsidy price received by sellers is Ps = Pd + 20. The market-clearing
condition is: 1000 – 10P = 30(P + 20), where P denotes the market price. This implies P = 10
and Q = 900. Since sellers receive the subsidy, P = Pd = 10 and Ps = Pd + 20 = 30. The surplus
implications of the subsidy are shown below:

With No Subsidy With Subsidy Impact of the

Subsidy
Consumer surplus A+B A+B+C+F+G C+F+G
($28,125) ($40,500) ($12,375)
Producer surplus C+E C+E+B+I B+I
($9,375) ($13,500) ($4,125)
Government spending on Zero B+C+F+G+H+I -B-C-F-G-H-I
subsidy ($18,000) (-$18,000)
Net benefits (consumer A+B+C+E A+B+C+E-H -H
surplus + producer ($37,500) ($36,000) (-$1,500)
surplus – government
spending)
Deadweight loss Zero H ($1,500) H ($1,500)
 P
100

S
30
B I
25
H S - 20
C F G
10
E
D Q
750 900 1,000
Economics 281 Chapter 10 In-class Problems Questions + Short Answers

Copyright Scott Beesley

1. Demand: P = 300 – 0.15 Q

Supply: P = 200 + 0.10 Q

a) Find the equilibrium P and Q.

b) Find CS, PS and TS in part a).

c) Assume that a tax of $20/unit is imposed. Find the following figures:

Consumer's Surplus (CS) Pincluding tax

Producer's Surplus (PS) Pnet-of-tax
Deadweight Loss (DWL)
Tax collected
Qtax

2. Demand: P = 10 – 0.004 Q

Supply: P = 4 + 0.006 Q

a) Find the equilibrium P and Q.

b) Find CS, PS and TS in part a).

c) Assume that a price ceiling of $6/unit is imposed, and the units go to the
highest WTP buyers. Find CS, PS, DWL, and the amount transacted.

d) Assume that a price ceiling of $6/unit is imposed, and the units go to the
lowest WTP buyers. Find CS, PS, DWL, and the amount transacted.
3. Domestic Demand: P = 25 – 0.01 Q

Domestic Supply: P = 15 + 0.01 Q

a) Find the equilibrium P and Q with no foreign trade.

b) Find CS, PS and TS in part a).

c) Assume that the world price is $23, and open trade is allowed. Find the
following figures: Imports/Exports (?), CS, PS, TS, Gain from trade.

d) Assume that the world price is $16, and open trade is allowed. Find the
following figures: Imports/Exports (?), CS, PS, TS, Gain from trade {relative, again,
to the no-trade case in part a).}

e) From the part d) outcome, impose an import tariff of $2.00 per unit. How
much of the gain from trade is lost? (i.e. what is the deadweight loss of the
tariff?)

f) Again, presume the starting point is d), the open-imports case. Now
presume a 300 unit import quota is imposed. Say the government auctions off
the quota for the maximum value. What is the remaining DWL of the quota?
Short answers:

1. a) Q = 400, P = 240

b) CS = 12,000; PS = 8,000; TS = 20,000

c)

Consumer's Surplus (CS) 7,680 Qtax 320

Producer's Surplus (PS) 5,120 Pincluding tax 252
Tax collected 6,400 Pnet-of-tax 232
(therefore TS = ) 19,200
TS (no tax) was 20,000
Deadweight Loss (DWL) 800

2. a) Q = 600, P = 7.60

b) CS = 720; PS = 1,080; TS = 1,800

c) CS = 1,111.11; PS = 333.33; TS = 1,444.44 DWL = 355.55

Quantity transacted = 333.33;

d) CS = 222.22; PS = 333.33; TS = 555.55 DWL = 1,244.44

Quantity transacted = 333.33;

3. a) P = 20, Q = 500

b) CS = 1,250; PS = 1,250; TS = 2,500

c) Exports = 600; CS = 200; PS = 3,200; TS = 3,400; Gain from trade = 900

d) Imports = 800; CS = 4,050; PS = 50; TS =4,100; Gain from trade = 1,600

e) Imports = 400; CS = 2,450; PS = 450; TS =3,700; Gain from trade = 1,200

The tariff cuts the gain from trade by 400 = the DWL of the tariff.

f) Dom. supply will be 350, imports = quota = 300, total Q = 650, P = 18.50,

CS = 2,112.50; PS = 612.50; Quota value = 750; TS = 3,475, whereas under

open trade, TS was 4,100 (from d)). The DWL of the quota is therefore 625.