Assignment Questions -
Q1) In class, we primarily discussed taxes. But we can use the same tools to examine the effects of subsidies. Consider the market for cheddar cheese and suppose that the government decides to encourage the consumption of cheddar cheese.
a) Suppose that the market for cheddar cheese is initially in equilibrium and is competitive and without externalities. Illustrate equilibrium in this market with a diagram.
b) Now suppose the government pays $2 to the buyers of cheddar cheese for each pound of cheese purchased. Illustrate on a diagram and summarize in words the effect of this subsidy on consumer surplus, producer surplus, tax revenue, and total surplus.
c) Does this subsidy lead to deadweight loss? Illustrate and explain.
2) Suppose that the market for roses is described by the following supply and demand equations:
QS = 2P
QD = 300 - P
a) Solve for the equilibrium price and the equilibrium quantity.
b) Suppose that a tax of T is placed on buyers, so the new demand equation is QD = 300 - (P+T).
Solve for the new equilibrium price and quantity. What happens to the price received by sellers, the price paid by buyers, and the quantity sold?
c) Tax revenue is T x Q. Use your answer to part (b) to solve for tax revenue as a function of T. Graph this relationship for T between 0 and 300.
d) The deadweight loss of a tax is the area of the triangle between the supply and demand curves. Recalling that the area of a triangle is 1/2 x base x height, solve for deadweight loss as a function of T. Graph this relationship for T between 0 and 300.
e) The government now levies a tax on roses of $200 per unit. Is this a good policy? Why or why not? Can you propose a better policy?
Q3) Illustrate with a diagram the effect of each of the following events on the market for labor in the laptop computer manufacturing industry.
a) The Federal Government buys a laptop for every high school student.
b) More college students choose to major in electrical engineering and computer science.
c) Laptop computer manufacturing firms build new manufacturing plants.
Q4) Some policymakers have proposed requiring employers to give workers certain fringe benefits, for example health insurance. This question asks you to consider the impact of such requirements on labor markets.
a) Suppose a new law requires firms to give each worker benefits costing the firm $3 for every hour that the worker is employed by the firm. How does this law affect the marginal profit that a firm earns from each worker? How does the law affect the demand curve for labor? Illustrate your answer on a graph; put the cash wage on the vertical axis.
b) If there is no change in labor supply, how would this law affect employment and wages?
c) Why might the labor supply curve shift in response to this law? Would this shift in labor supply raise or lower the impact of on wages and employment? Illustrate your answer.
Q5) The Massive Pharmaceutical Company (MPC) holds a patent on one of its discoveries, the drug Profitor.
a) Assuming that the production of Profitor involves rising marginal cost, draw a diagram to illustrate MPC's profit-maximizing price and quantity. Also show MPC's profits.
b) Now suppose that the government imposes a tax on each bottle of Profitor produced. On a new diagram, illustrate MPC's new price and quantity. How does each compare to your answer in part (a)?
c) Although it is not easy to see in your diagrams, the tax reduces MPC's profit. Explain why this must be true.
d) Instead of the tax per bottle, suppose that the government imposes a tax on MPC of $25,000 regardless of how many bottles are produced. How does this tax affect MPC's price, quantity, and profits? Explain carefully.