ECON 101 Tutorial: Week 3

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ECON 101 Tutorial Week 3

• Shane Murphy
• s.murphy5_at_lancaster.ac.uk
• Office Hours Monday 300-400 LUMS C86

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Outline

• Roll Call
• Problems
• Discussion

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Chapter 7 Exercise 7

• Why might we want to think about market price as
  the outcome of a bargaining model?
• Market price is really an outcome of the
  bargaining model. Suppliers are offering goods to
  consumers at different prices and consumers have
  to make decisions about whether the prices they
  are offered represents a net economic benefit to
  them. There is an interaction between suppliers
  and consumers, therefore, which can be seen as a
  bargaining process an agreed outcome between
  two interested and competing economic agents. For
  example suppliers respond to the decisions made
  by consumers if too few people buy their
  product then they will be forced to take action
  to improve the product offering, lower the price
  or even drop out of the market altogether.

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Chapter 8 Exercise 2

• The government has decided that the free market
  price of tobacco is too low.
• Suppose the government imposes a binding price
  floor in the tobacco market. Use a diagram to
  show the effect on the price and quantity. Is
  there a shortage or surplus? What does the market
  outcome depend on?
• Tobacco producers complain that he price floor
  has reduced their total revenue. Is this
  possible? Why?
• In response to producers complaints, the
  government agrees to purchase all of the surplus
  tobacco at the price floor. Compared to the basic
  price floor, who benefits from this new policy?
  Who loses?

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Chapter 8 Exercise 2

• The government has decided that the free market
  price of tobacco is too low.
• Suppose the government imposes a binding price
  floor in the tobacco market. Use a diagram to
  show the effect on the price and quantity. Is
  there a shortage or surplus? What does the market
  outcome depend on?

The imposition of a binding price floor in the
tobacco market is shown. In the absence of the
price floor, the price would be P1 and the
quantity would be Q1. With the floor set at Pf,
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.
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Chapter 8 Exercise 2

• The government has decided that the free market
  price of tobacco is too low.
• Tobacco producers complain that he price floor
  has reduced their total revenue. Is this
  possible? Why?
• The tobacco producers complaint that their total
  revenue has declined is correct if demand is
  price elastic. With price elastic demand, the
  percentage decline in quantity would exceed the
  percentage rise in price, so total revenue would
  decline.

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Chapter 8 Exercise 2

• The government has decided that the free market
  price of tobacco is too low.
• In response to producers complaints, the
  government agrees to purchase all of the surplus
  tobacco at the price floor. Compared to the basic
  price floor, who benefits from this new policy?
  Who loses?
• If the government purchases all the surplus
  tobacco at the price floor, producers benefit and
  taxpayers lose. Producers would produce quantity
  Q3 of tobacco, and their total revenue would
  increase substantially. But consumers would buy
  only quantity Q2 of tobacco, so they are in the
  same position as before. Taxpayers lose because
  they would be financing the purchase of the
  surplus tobacco through higher taxes.

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Chapter 9 Exercise 6

• Suppose that the government subsidizes a good
  for each unit of the good sold, the government
  pays 2 to the buyer. How does the subsidy affect
  CS, PS, TR, TS? Is the a DL?

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Chapter 9 Exercise 6

• Suppose that the government subsidizes a good
  for each unit of the good sold, the government
  pays 2 to the buyer. How does the subsidy affect
  CS, PS, TR, TS? Is the a DL?

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Chapter 9 Exercise 9

• Suppose the market is described by
• Qs 2P Qd 300-P
• Solve for the equilibrium price and quantity.
• Suppose that a tax of T is placed on buyers so
  demand is Qd 300 (PT). Solve for the new
  equilibrium. What happens to the price receivd by
  sellers, the price paid by buyers, and the
  quantity?
• Tax revenue is TxQ. Use your answer to part (b)
  to solve for tax revenue as a function of T.
  Graph the relationship for T between 0 and 300.
• The deadweight loss of a tax is the area of the
  triangle between the supply and demand curves.
  Graph the relationship between DL and T between 0
  and 300.
• The government now levies a tax on this good of
  200 per unit. Is this a good policy? Why or why
  not? Can you propose a better policy?

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Chapter 9 Exercise 9

• Suppose the market is described by
• Qs 2P Qd 300-P
• Solve for the equilibrium price and quantity.
• Setting quantity supplied equal to quantity
  demanded gives 2P 300 P. Adding P to both
  sides of the equation gives 3P 300. Dividing
  both sides by 3 gives P 100, which is the
  equilibrium price. Plugging P 100 back into
  either equation for quantity demanded or supplied
  gives Q 200 as the equilibrium quantity.

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Chapter 9 Exercise 9

• Suppose the market is described by
• Qs 2P Qd 300-P
• Suppose that a tax of T is placed on buyers so
  demand is Qd 300 (PT). Solve for the new
  equilibrium. What happens to the price received
  by sellers, the price paid by buyers, and the
  quantity?
• Now P is the price received by sellers and PT is
  the price paid by buyers. Equating quantity
  demanded to quantity supplied gives 2P 300 -
  (PT). Adding P to both sides of the equation
  gives 3P 300 T. Dividing both sides by 3
  gives P 100 - T/3. This is the price received
  by sellers, and is clearly less than before the
  tax was imposed. The buyers pay a price equal to
  the price received by sellers plus the tax (PT
  100 2T/3). The quantity sold is now Q 2P
  200 2T/3.

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Chapter 9 Exercise 9

• Suppose the market is described by
• Qs 2P Qd 300-P
• Tax revenue is TxQ. Use your answer to part (b)
  to solve for tax revenue as a function of T.
  Graph the relationship for T between 0 and 300.
• Since tax revenue is equal to T x Q and Q 200 -
  2T/3, tax revenue equals 200T - 2T2/3. Tax
  revenue is zero at T 0 and at T 300.

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Chapter 9 Exercise 9

• Suppose the market is described by Qs 2P Qd
  300-P
• The deadweight loss of a tax is the area of the
  triangle between the supply and demand curves.
  Graph the relationship between DL and T between 0
  and 300.
• The area of the triangle (laid on its side) that
  represents the deadweight loss is 1/2 x base x
  height, where the base is the change in the
  price, which is the size of the tax (T) and the
  height is the amount of the decline in quantity
  (2T/3). So the deadweight loss equals 1/2 x T x
  2T/3 T2/3. This rises exponentially from 0
  (when T 0) to 45,000 when T 300.

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Chapter 9 Exercise 9

• Suppose the market is described by
• Qs 2P Qd 300-P
• The government now levies a tax on this good of
  200 per unit. Is this a good policy? Why or why
  not? Can you propose a better policy?
• A tax of 200 per unit is a bad idea, because
  it's in a region in which tax revenue is
  declining. Tax revenue is calculated as 200T -
  2T2/3 2002 2/3(2002) 40,000 26,666
  13,333. The government could reduce the tax to
  150 per unit and get more tax revenue (15,000).
  The lower tax would also cause a smaller
  deadweight loss. The deadweight loss is
  calculated as T2/3 so when T is 200 the
  deadweight loss is 13,333 and when T is 150 the
  deadweight loss is only 7,500. A tax of 150 per
  unit is therefore a better policy.

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Discussion

• Is deadweight loss always bad?
• How much should we concern ourselves with
  avoiding deadweight loss?
• When is deadweight loss acceptable?
• How can Santa be described as a deadweight loss?