Unlock document.
This document is partially blurred.
Unlock all pages and 1 million more documents.
Get Access
S-61
1. In order to ingratiate himself with voters, the mayor of Gotham City decides to lower
the price of taxi rides. Assume, for simplicity, that all taxi rides are the same distance
and therefore cost the same. The accompanying table shows the demand and supply
schedules for taxi rides.
a. Assume that there are no restrictions on the number of taxi rides that can be sup-
plied (there is no medallion system). Find the equilibrium price and quantity.
b. Suppose that the mayor sets a price ceiling at $5.50. How large is the shortage of
rides? Illustrate with a diagram. Who loses and who benefits from this policy?
c. Suppose that the stock market crashes and, as a result, people in Gotham City
are poorer. This reduces the quantity of taxi rides demanded by 6 million rides
per year at any given price. What effect will the mayor’s new policy have now?
4
CHAPTER
Price Controls and Quotas:
Meddling with Markets
$7.00 10 12
6.50 11 11
Quantity of rides
(millions per year)
Fare
(per ride) Quantity demanded Quantity supplied
KrugWellsECPS4e_Macro_CH04.indd S-61KrugWellsECPS4e_Macro_CH04.indd S-61 1/19/15 2:19 PM1/19/15 2:19 PM
Solution
1. a. The equilibrium in the market for taxi rides is shown by E1 in the accompany-
ing diagram. The equilibrium price is $6.50; at that price, the quantity demanded
equals the quantity supplied—11 million taxi rides per year. The demand and sup-
ply curves (D1 and S) illustrate this initial situation.
S
$7.00
6.50
6.00
Fare
(per ride)
E1
= 4 million. Taxi drivers clearly lose out: there are fewer taxi rides supplied than
before, and at a lower price. The impact on consumers is unclear: fewer people
now manage to get rides, but those who do, get them at a lower price.
S
$7.00
Fare
(per ride)
S-62 CHAPTER 4 PRICE CONTROLS AND QUOTAS: MEDDLING WITH MARKETS
KrugWellsECPS4e_Macro_CH04.indd S-62KrugWellsECPS4e_Macro_CH04.indd S-62 1/19/15 2:19 PM1/19/15 2:19 PM
c. The new demand curve is D2. Now the price ceiling has no effect: the equilibrium
is point E2 and the market price settles at $5, which is below the mandated price
ceiling of $5.50. There will be 8 million taxi rides demanded and supplied, at a
price of $5 each.
S
$7.00
6.50
Fare
(per ride)
E1
d. The accompanying diagram illustrates the effect of the quota of 10 million taxi
rides. The quantity of taxi rides is now 10 million, at a price of $7. The quota rent
per ride is $1.
S
$7.00
6.50
Fare
(per ride)
E1
Quota
rent
CHAPTER 4 PRICE CONTROLS AND QUOTAS: MEDDLING WITH MARKETS S-63
KrugWellsECPS4e_Macro_CH04.indd S-63KrugWellsECPS4e_Macro_CH04.indd S-63 1/19/15 2:19 PM1/19/15 2:19 PM
Solution
2. In the late eighteenth century, the price of bread in New York City was controlled,
set at a predetermined price above the market price.
a. Draw a diagram showing the effect of the policy. Did the policy act as a price ceil-
ing or a price floor?
2. a. Panel (a) of the accompanying diagram illustrates the effect of this policy. Since
the price is set above the market equilibrium price, this policy acts as a price floor:
it raises the price artificially above the equilibrium. As a result, too much bread is
produced: there is a surplus.
Price
of bread
Price
of bread
S1
S2
Surplus
Price
ceiling
Panel (a) Panel (b)
E2
b. As with all price floors above the equilibrium price, there are several associated
inefficiencies. First, some transactions that would have occurred at the unregu-
lated market price no longer occur. Second, there is inefficient allocation of
sales among bakers. Some bakers who are willing to sell at a lower price don’t get
d. As with all price ceilings below the equilibrium price, there are several associated
inefficiencies. First, there is inefficiently low quantity transacted. There is a
persistent shortage of bread, and some transactions that would have occurred
S-64 CHAPTER 4 PRICE CONTROLS AND QUOTAS: MEDDLING WITH MARKETS
KrugWellsECPS4e_Macro_CH04.indd S-64KrugWellsECPS4e_Macro_CH04.indd S-64 1/19/15 2:19 PM1/19/15 2:19 PM
Solution
3. The U.S. Department of Agriculture (USDA) administers the price floor for butter,
which the 2008 Farm Bill set at $1.05 per pound. At that price, according to data
from the USDA, the quantity of butter supplied in 2010 was 1.7 billion pounds,
Price of butter
(per pound)
S
$1.20
1.15
1.10
1.05
a. In the absence of a price floor, how much consumer surplus is created? How
much producer surplus? What is the total surplus?
b. With the price floor at $1.05 per pound of butter, consumers buy 1.6 billion
pounds of butter. How much consumer surplus is created now?
3. a. In the absence of a price floor, consumer surplus is the area below the demand
curve but above the equilibrium price of $1.00: it is (($1.15 − $1.00) × 1.65 bil-
lion)/2 = $123.75 million. Producer surplus is the area above the supply curve
but below the equilibrium price of $1.00: it is (($1.00 − $0.85) × 1.65 billion)/2
CHAPTER 4 PRICE CONTROLS AND QUOTAS: MEDDLING WITH MARKETS S-65
KrugWellsECPS4e_Macro_CH04.indd S-65KrugWellsECPS4e_Macro_CH04.indd S-65 1/19/15 2:19 PM1/19/15 2:19 PM
Solution
S-66 CHAPTER 4 PRICE CONTROLS AND QUOTAS: MEDDLING WITH MARKETS
d. The USDA buys 100 million pounds of butter at a price of $1.05 per pound, for a
4. The accompanying table shows hypothetical demand and supply schedules for milk
per year. The U.S. government decides that the incomes of dairy farmers should be
maintained at a level that allows the traditional family dairy farm to survive. So it
implements a price floor of $1 per pint by buying surplus milk until the market price
is $1 per pint.
$1.20 550 850
Quantity of milk
(millions of pints per year)
Price of milk
(per pint) Quantity demanded Quantity supplied
a. How much surplus milk will be produced as a result of this policy?
b. What will be the cost to the government of this policy?
c. Since milk is an important source of protein and calcium, the government decides
4. a. With demand of D1 and supply of S, the equilibrium would be at point E1 in the
accompanying diagram. However, with a price floor at $1, the quantity supplied is
750 million pints and the quantity demanded is 650 million pints. So the policy
causes a surplus of milk of 100 million pints per year.
S
$1.20
Price of milk
(per pint)
KrugWellsECPS4e_Macro_CH04.indd S-66KrugWellsECPS4e_Macro_CH04.indd S-66 1/19/15 2:19 PM1/19/15 2:19 PM
b. In order to sustain this price floor (to prevent black market sales of surplus milk
below the price floor), the government has to buy up the surplus of milk. Buying
100 million pints of milk at a price of $1 each costs the government $100 million.
c. As a result of sales of cheap milk to schools, the quantity demanded falls by 50
million pints per year at any price: the demand curve shifts leftward to the new
demand curve D2. Without the price floor, the equilibrium would now be at point
S
$1.20
1.10
1.00
Price of milk
(per pint)
Surplus of
150 million pints
CHAPTER 4 PRICE CONTROLS AND QUOTAS: MEDDLING WITH MARKETS S-67
KrugWellsECPS4e_Macro_CH04.indd S-67KrugWellsECPS4e_Macro_CH04.indd S-67 1/19/15 2:19 PM1/19/15 2:19 PM
5. European governments tend to make greater use of price controls than does the U.S.
government. For example, the French government sets minimum starting yearly
€45,000 200,000 325,000
€40,000 220,000 320,000
Wage
(per year)
Quantity supplied
(new job seekers
per year)
Quantity demanded
(new job offers
per year)
a. In the absence of government interference, what are the equilibrium wage and
number of graduates hired per year? Illustrate with a diagram. Will there be any-
one seeking a job at the equilibrium wage who is unable to find one—that is, will
there be anyone who is involuntarily unemployed?
S-68 CHAPTER 4 PRICE CONTROLS AND QUOTAS: MEDDLING WITH MARKETS
KrugWellsECPS4e_Macro_CH04.indd S-68KrugWellsECPS4e_Macro_CH04.indd S-68 1/19/15 2:19 PM1/19/15 2:19 PM
Solution
5. a. The equilibrium wage is €30,000, and 290,000 workers are hired. There is full
employment: nobody is involuntarily unemployed. The equilibrium is at point E.
S
€45
Wage
(thousands
per year)
Minimum wage
€40,000
Surplus
b. With a minimum wage of €35,000, there is a surplus of workers of 60,000 (the
quantity supplied is 310,000 and the quantity demanded is 250,000). That is,
there are 60,000 workers who are involuntarily unemployed. At a minimum wage
of €40,000, there is a surplus of workers of 100,000: this is the number of invol-
untarily unemployed workers.
c. The higher the minimum wage, the larger the amount of involuntary unemploy-
ment. The people who benefit from this policy are those workers who succeed in
CHAPTER 4 PRICE CONTROLS AND QUOTAS: MEDDLING WITH MARKETS S-69
KrugWellsECPS4e_Macro_CH04.indd S-69KrugWellsECPS4e_Macro_CH04.indd S-69 1/19/15 2:19 PM1/19/15 2:19 PM
Solution
S-70 CHAPTER 4 PRICE CONTROLS AND QUOTAS: MEDDLING WITH MARKETS
6. For the last 80 years the U.S. government has used price supports to provide income
assistance to American farmers. To implement these price supports, at times the
government has used price floors, which it maintains by buying up the surplus farm
products. At other times, it has used target prices, a policy by which the government
gives the farmer an amount equal to the difference between the market price and the
target price for each unit sold. Consider the market for corn depicted in the accom-
panying diagram.
$5
4
Price of corn
(per bushel)
S
a. If the government sets a price floor of $5 per bushel, how many bushels of corn
are produced? How many are purchased by consumers? By the government? How
much does the program cost the government? How much revenue do corn farm-
ers receive?
6. a. With a price floor of $5, the quantity of corn supplied is 1,200 bushels. The quan-
tity demanded is only 800 bushels: there is a surplus of 400 bushels. The govern-
ment therefore has to buy up the surplus of 400 bushels, at a price of $5 each:
the program costs the government 400 × $5 = $2,000. Corn farmers sell 1,200
bushels (800 to consumers and 400 to the government) and therefore make 1,200
Solution
7. The waters off the North Atlantic coast were once teeming with fish. But due to
over fishing by the commercial fishing industry, the stocks of fish became seriously
depleted. In 1991, the National Marine Fishery Service of the U.S. government imple-
$20 6 15
18 7 13
16 8 11
Quantity of swordfish
(millions of pounds per year)
Price of swordfish
(per pound) Quantity demanded Quantity supplied
7. a. The quantity sold is 7 million pounds, at a price of $18 per pound. On each
pound of fish caught, each fisherman earns quota rent of $6, as shown in the
accompanying diagram.
S
$20
18
Price of swordfish
(per pound)
Quota
rent
Quota
CHAPTER 4 PRICE CONTROLS AND QUOTAS: MEDDLING WITH MARKETS S-71
KrugWellsECPS4e_Macro_CH04.indd S-71KrugWellsECPS4e_Macro_CH04.indd S-71 1/19/15 2:19 PM1/19/15 2:19 PM
Solution
S-72 CHAPTER 4 PRICE CONTROLS AND QUOTAS: MEDDLING WITH MARKETS
8. In Maine, you must have a license to harvest lobster commercially; these licenses are
issued yearly. The state of Maine is concerned about the dwindling supplies of lob-
sters found off its coast. The state fishery department has decided to place a yearly
quota of 80,000 pounds of lobsters harvested in all Maine waters. It has also decided
to give licenses this year only to those fishermen who had licenses last year. The
accompanying diagram shows the demand and supply curves for Maine lobsters.
$22
20
18
16
14
Price of
lobster
(per pound)
8. a. Without government restrictions, the equilibrium in the market for lobsters is
at point E. The equilibrium price for lobsters is $10 per pound. At that price, the
quantity demanded and the quantity supplied are 120,000 pounds of lobsters.
$22
20
18
Price of lobster
(per pound)
Quota
KrugWellsECPS4e_Macro_CH04.indd S-72KrugWellsECPS4e_Macro_CH04.indd S-72 1/19/15 2:20 PM1/19/15 2:20 PM
b. The demand price of 80,000 pounds of lobsters is $14.
9. The accompanying diagram shows data from the U.S. Bureau of Labor Statistics on
the average price of an airline ticket in the United States from 1975 until 1985,
adjusted to eliminate the effect of inflation (the general increase in the prices of all
goods over time). In 1978, the United States Airline Deregulation Act removed the
price floor on airline fares, and it also allowed the airlines greater flexibility to offer
new routes.
Price of airline
ticket (index:
1975 = 100)
160
CHAPTER 4 PRICE CONTROLS AND QUOTAS: MEDDLING WITH MARKETS S-73
Solution
9. a. When a binding price floor—one that is set above the equilibrium price—is
removed, you should expect the price of the good to fall. From looking at the data
in the figure, you should think that the pre - 1978 price floor was ineffective, since
the price of an airline ticket actually rose after 1978. In the accompanying dia-
gram, the price floor, PF, is non binding: it is set below the equilibrium price, PE. In
that case, removing the price floor would not lead to a decrease in price.
S
Price of
airline ticket
10. Many college students attempt to land internships before graduation to burnish
their resumes, gain experience in a chosen field, or try out possible careers. The hope
shared by all of these prospective interns is that they will find internships that pay
more than typical summer jobs, such as waiting tables or flipping burgers.
a. With wage measured on the vertical axis and number of hours of work on the
S-74 CHAPTER 4 PRICE CONTROLS AND QUOTAS: MEDDLING WITH MARKETS
KrugWellsECPS4e_Macro_CH04.indd S-74KrugWellsECPS4e_Macro_CH04.indd S-74 1/19/15 2:20 PM1/19/15 2:20 PM
Solution
10. a. Here the market-clearing wage, W1, is non-binding because it is above the mini-
mum wage. In this case the minimum wage has no effect on the market for
interns: the number of hours transacted in the market equilibrium, X1, is the
same as if there had been no minimum wage.
S1
Wage
b. The economic downturn will result in an increase in the supply of interns. The
supply curve will shift outward to its new position at S2 and result in a new equi-
librium wage of zero. The minimum wage is now binding.
S2
Wage
Minimum
S1
CHAPTER 4 PRICE CONTROLS AND QUOTAS: MEDDLING WITH MARKETS S-75
KrugWellsECPS4e_Macro_CH04.indd S-75KrugWellsECPS4e_Macro_CH04.indd S-75 1/19/15 2:20 PM1/19/15 2:20 PM
Solution
11. Suppose it is decided that rent control in New York City will be abolished and that
market rents will now prevail. Assume that all rental units are identical and so are
offered at the same rent. To address the plight of residents who may be unable to pay
the market rent, an income supplement will be paid to all low - income households
equal to the difference between the old controlled rent and the new market rent.
a. Use a diagram to show the effect on the rental market of the elimination of rent
11. a. With a price ceiling at PC, the quantity bought and sold is QC, indicated by
point A. The ceiling at PC is eliminated and the rent returns to the market equilib-
rium E1, with an equilibrium rent of P1. The quantity supplied increases from QC
to the equilibrium quantity Q1. At the same time, you should expect the quality of
S-76 CHAPTER 4 PRICE CONTROLS AND QUOTAS: MEDDLING WITH MARKETS
KrugWellsECPS4e_Macro_CH04.indd S-76 1/19/15 2:20 PM
CHAPTER 4 PRICE CONTROLS AND QUOTAS: MEDDLING WITH MARKETS S-77
b. The income - supplement policy causes a rightward shift of the demand curve from
D1 to D2. This results in an increase in the equilibrium rent, from P1 to P2, and an
increase in the equilibrium quantity, from Q1 to Q2, as the equilibrium changes
from E1 to E2.
S
Monthly
rent
c. Landlords are clearly better off as a result of these two policies: more landlords
rent out apartments, and at a higher monthly rent. It is not clear whether
tenants are better or worse off. Some tenants who previously could not get
KrugWellsECPS4e_Macro_CH04.indd S-77KrugWellsECPS4e_Macro_CH04.indd S-77 1/19/15 2:20 PM1/19/15 2:20 PM
