Tutorial_5_solutions

1.Lovers of classical music persuade Congress to impose a price ceiling of $40 per concert ticket.

As a result of this policy, do more or fewer people attend classical music concerts?

2.The government has decided that the free-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 diagram 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 the price floor has reduced their total revenue. Is this possible?

Explain.

c.In response to farmers’ complaints, the government agrees to purchase all of the surplus

cheese at the price floor. Compared to the basic price floor, who benefits from this new

policy? Who loses?

3.Suppose that the federal government requires producers to pay a $0.50 tax on each gallon of gasoline sold.

a.Draw a supply-and-demand diagram of the market for gasoline before the tax. Show the price paid

by consumers, the price received by producers, and the quantity of gasoline sold. What is the

difference between the price paid by consumers and the price received by sellers?

b.Now draw a supply-and-demand diagram for the gasoline market with the tax. Show the price paid

by consumers, the price received by producers, and the quantity of gasoline sold. What is the

difference between the price paid by buyers and the price received by sellers? Has the quantity of

gasoline sold increased or decreased?

4. A U.S. senator wants to raise tax revenue and make workers better off. A staff member proposes raising the

payroll tax paid by firms and using part of the extra revenue to reduce the payroll tax paid by workers.

Would this accomplish the senator’s goal? Explain.

5.If the government places a $500 tax on luxury cars, will the price paid by consumers rise by more than $500,

less than $500, or exactly $500? Explain.

6.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 diagram.

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?

1. If the price ceiling of $40 per ticket is below the equilibrium price, then quantity demanded exceeds quantity

supplied, so there will be a shortage of tickets. The policy decreases the number of people who attend classical music concerts, because the quantity supplied is lower because of the lower price.

2.

a. The imposition of a binding price floor in the cheese market is shown in Figure 1. In the absence of the

price floor, the price would be P1 and the quantity would be Q1. With the floor set at P f, which is greater than P1, the quantity demanded is Q2, while quantity supplied is Q3, so there is a surplus of cheese in the amount Q3 –Q2.

b. The farmers’ complaint that their total revenue has declined is correct if demand is elasti

c. With elastic

demand, the percentage decline in quantity would exceed the percentage rise in price, so total revenue would decline.

c. If the government purchases all the surplus cheese at the price floor, producers benefit and taxpayers lose.

Producers would produce quantity Q3 of cheese, and their total revenue would increase substantially.

However, consumers would buy only quantity Q2 of cheese, so they are in the same position as before.

Taxpayers lose because they would be financing the purchase of the surplus cheese through higher taxes.

Figure 1.

3.

a. Figure 2 shows the market for gasoline without the tax. The equilibrium price is P1 and

the equilibrium quantity is Q1. The price paid by consumers is the same as the price

received by producers.

b. When the tax is imposed, it drives a wedge of $0.50 between supply and demand, as

shown in Figure 3. The price paid by consumers is P2, while the price received by

producers is P2 – $0.50. The quantity of gasoline sold declines to Q2.

Figure 2. Figure 3.

4. Reducing the payroll tax paid by firms and using part of the extra revenue to reduce the payroll tax paid

by workers would not make workers better off, because the division of the burden of a tax depends on the elasticity of supply and demand and not on who must pay the tax. Because the tax wedge would be larger, it is likely that both firms and workers, who share the burden of any tax, would be worse off.

5. If the government imposes a $500 tax on luxury cars, the price paid by consumers will rise less than $500,

in general. The burden of any tax is shared by both producers and consumers–the price paid by consumers rises and the price received by producers falls, with the difference between the two equal to the amount of the tax. The only exceptions would be if the supply curve were perfectly elastic or the demand curve were perfectly inelastic, in which case consumers would bear the full burden of the tax and the price paid by consumers would rise by exactly $500.

6.

a. It does not matter whether the tax is imposed on producers or consumers–the effect will be the same.

With no tax, as shown in Figure 4, the demand curve is D1 and the supply curve is S1. If the tax is imposed on producers, the supply curve shifts up by the amount of the tax (50 cents) to S2. Then the equilibrium quantity is Q2, the price paid by consumers is P2, and the price received (after taxes are paid) by producers is P2 – 50 cents. If the tax is instead imposed on consumers, the demand curve shifts down by the amount of the tax (50 cents) to D2. The downward shift in the demand curve (when the tax is imposed on consumers) is exactly the same magnitude as the upward shift in the supply curve when the tax is imposed on producers. So again, the equilibrium quantity is Q2, the price paid by consumers is P2 (including the tax paid to the government), and the price received by producers is P2 – 50 cents.

Figure 4

b. The more elastic the demand curve is, the more effective this tax will be in reducing the quantity of gasoline consumed. Greater elasticity of demand means that quantity falls more in response to the rise in the price of gasoline. Figure 5 illustrates this result. Demand curve D1 represents an elastic demand curve, while demand curve D2 is more inelasti

c. The tax will cause a greater decline in the quantity sold when demand is elastic.

Figure 5.

c.The consumers of gasoline are hurt by the tax because they get less gasoline at a higher price.

d. Workers in the oil industry are hurt by the tax as well. With a lower quantity of gasoline being produced, some workers may lose their jobs. With a lower price received by producers, wages of workers might declin

e.