Chapter 9
Applying the Competitive Model
MULTIPLE CHOICE
Choose the one alternative that best completes the statement or answers the question.
1) Mister Jones was selling his house. The asking price was $220,000, and Jones decided he
would take no less than $200,000. After some negotiation, Mister Smith purchased the house
for $205,000. Smith's consumer surplus is
A) $5,000.
B) $15,000.
C) $20,000.
D) not able to be calculated from the information given.
Answer: D
Diff: 1
Topic: Consumer Welfare
2) Mary purchased a stuffed animal toy for $5. After a few weeks, someone offered her $100
for the toy. Mary refused. One can conclude that Mary's consumer surplus from the toy is
A) less than $5.
B) at least $95.
C) at least $100.
D) $105.
Answer: B
Diff: 1
Topic: Consumer Welfare
3) Joe's demand for spring water can be represented as p = 10 - Q (where p is measured in
$/gallon and Q is measured in gallons). He recently discovered a spring where water can be
obtained free of charge. His consumer surplus from this water is
A) $0.
B) $50.
C) $100.
D) unknown based upon the information provided.
Answer: B
Diff: 1
Topic: Consumer Welfare
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Chapter 9/Applying the Competitive Model
Figure 9.1
4) Figure 9.1 shows the market demand curve for telecommunication while driving one's car
(time spent on the car phone). The current price is $0.35 per minute. If the price were to
increase by ten cents per minute, consumer surplus will
A) fall to $820.
B) fall by $84.
C) fall by $58.
D) fall to $369.
Answer: B
Diff: 1
Topic: Consumer Welfare
5) Figure 9.1 shows the market demand curve for telecommunication while driving one's car
(time spent on the car phone). At the current price of $0.35 per minute, consumer surplus
equals
A) $301.00.
B) $924.50.
C) $1,225.50.
D) $1,250.00.
Answer: B
Diff: 1
Topic: Consumer Welfare
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Chapter 9/Applying the Competitive Model
6) As the price of a good increases, the loss in consumer surplus is larger,
A) the more elastic demand is.
B) the more money previously spent on the good.
C) the less money previously spent on the good.
D) the smaller the price increase.
Answer: B
Diff: 1
Topic: Consumer Welfare
7) If lower-income households spend a greater share of their income on cigarettes than do
higher-income households, then a tax that raises the price of cigarettes will
A) cause lower-income households to incur a greater loss of consumer surplus than that
incurred by higher-income households.
B) cause higher- income households to incur a greater loss of consumer surplus than that
incurred by lower-income households.
C) raise consumer surplus among higher-income households.
D) cause consumer surplus to decline among smokers, but the relative impact cannot be
determined from the given information.
Answer: D
Diff: 2
Topic: Consumer Welfare
8) Suppose consumers of cigarettes can be classified into two groups: heavy users and light
users. Heavy users purchase more cigarettes and are less sensitive to price changes relative to
light users. To determine whether a heavy user suffers a greater loss of consumer surplus
than a light user does when the price of cigarettes increases, one would need to know
A) each group's average income.
B) the actual quantities purchased by each.
C) each individual's price elasticity of demand.
D) no additional information.
Answer: D
Diff: 2
Topic: Consumer Welfare
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Chapter 9/Applying the Competitive Model
9) Sarah's demand curve for whiskey has the same slope as Pete's; however, it lies to the right of
Pete's. An increase in the price of whiskey will cause
A) Sarah to incur a greater loss of consumer surplus than Pete will.
B) Pete to incur a greater loss of consumer surplus than Sarah will.
C) Sarah and Pete to incur the same loss of consumer surplus.
D) Sarah's demand curve to shift closer to Pete's.
Answer: A
Diff: 2
Topic: Consumer Welfare
10) Producer surplus is equal to
A) the area under the supply curve.
B) the difference between price and average cost for all units sold.
C) the difference between price and marginal cost for all units sold.
D) the firm's profit when fixed costs exist.
Answer: C
Diff: 1
Topic: Producer Welfare
11) Mister Jones was selling his house. The asking price was $220,000, and Jones decided he
would take no less than $200,000. After some negotiation, Mister Smith purchased the house
for $205,000. Jones' producer surplus is
A) $5,000.
B) $15,000.
C) $20,000.
D) not able to be calculated from the information given.
Answer: A
Diff: 1
Topic: Producer Welfare
12) Suppose the market supply curve is p = 5 + Q. At a price of 10, producer surplus equals
A) 50.
B) 25.
C) 12.50.
D) 10.
Answer: C
Diff: 1
Topic: Producer Welfare
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Chapter 9/Applying the Competitive Model
13) In the short run, if a firm operates, it earns a profit of $500. The fixed costs of the firm are
$100. This firm has a producer surplus of
A) $500.
B) $100.
C) $400.
D) $600.
Answer: C
Diff: 1
Topic: Producer Surplus
14) Economists claim that measuring society's welfare as CS + PS
A) is inappropriate since ultimately everyone is a consumer.
B) is valid only when the same person could be either a consumer or a producer.
C) treats the gains to consumers and producers equally.
D) is not commonly accepted.
Answer: C
Diff: 1
Topic: Competition Maximizes Welfare
15) If a market produces a level of output below the competitive equilibrium, then
A) social welfare is not maximized.
B) consumer surplus might still be maximized.
C) the actual price will be below the equilibrium price.
D) social welfare might still be enhanced if a price ceiling keeps price below the competitive
price.
Answer: A
Diff: 1
Topic: Competition Maximizes Welfare
16) A competitive market maximizes social welfare because in a competitive market
A) profits are zero.
B) price equals marginal cost of the last unit produced.
C) price equals average cost of the last unit produced.
D) there is free entry and exit.
Answer: B
Diff: 1
Topic: Competition Maximizes Welfare
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Chapter 9/Applying the Competitive Model
17) If a market produces a level of output that exceeds the competitive equilibrium output, then
A) social welfare will be higher.
B) producer surplus will be higher.
C) marginal cost will exceed price.
D) All of the above.
Answer: C
Diff: 1
Topic: Competition Maximizes Welfare
18) If an economist states that not enough of a good is being produced, she usually means that
A) not everyone can afford the good.
B) price exceeds marginal cost.
C) consumer surplus equals zero.
D) at equilibrium, some people who still wish to buy the good cannot find a seller.
Answer: B
Diff: 2
Topic: Competition Maximizes Welfare
19) Deadweight loss occurs when
A) producer surplus is greater than consumer surplus.
B) the maximum level of total welfare is not achieved.
C) consumer surplus is reduced.
D) an inferior good is consumed.
Answer: B
Diff: 1
Topic: Competition Maximizes Welfare
20) The services of real estate brokers are provided in a competitive market. If the state Board of
Realtors enacts several requirements that limit the number of real estate brokers, which of the
following is most likely to occur?
A) The supply curve of real estate brokers will shift to the left.
B) The supply curve of real estate brokers will shift to the right.
C) Social welfare will remain unchanged.
D) The supply curve will remain unchanged.
Answer: A
Diff: 1
Topic: Policies that Shift Supply Curves
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Chapter 9/Applying the Competitive Model
21) The services of real estate brokers are provided in a competitive market. If the state Board of
Realtors enacts several requirements that limit the number of real estate brokers, which of the
following is most likely to occur?
A) Consumer surplus will increase.
B) Producer surplus will increase.
C) Entry of new brokers will increase.
D) Social welfare will increase.
Answer: B
Diff: 2
Topic: Policies that Shift Supply Curves
22) The services of real estate brokers are provided in a competitive market. If the state Board of
Realtors enacts several requirements that limit the number of real estate brokers, then
consumer surplus will most likely
A) increase.
B) decrease.
C) remain unchanged.
D) There is not enough information to answer.
Answer: B
Diff: 1
Topic: Policies that Shift Supply Curves
23) The services of real estate brokers are provided in a competitive market. If the state Board of
Realtors enacts several requirements that limit the number of real estate brokers, then social
welfare will most likely
A) not change but there will be a transfer from consumer to producer.
B) not change but there will be a transfer from producer to consumer.
C) decrease although producers are made better off.
D) decrease although consumers are made better off.
Answer: C
Diff: 1
Topic: Policies that Shift Supply Curves
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Chapter 9/Applying the Competitive Model
Figure 9.2
24) Figure 9.2 shows supply and demand curves for apartment units in a large city. If the city
government passes a law that establishes $350 per month as the legal maximum rent, the loss
in social welfare equals
A) b + c.
B) f.
C) a.
D) f + g.
Answer: D
Diff: 1
Topic: Policies that Create a Wedge
25) Figure 9.2 shows supply and demand curves for apartment units in a large city. If the city
government passes a law that establishes $350 per month as the legal maximum rent,
deadweight loss occurs because
A) consumers place a greater value on the last apartment unit than the cost to supply it.
B) the supplier of the last apartment unit receives a rental price that is less than the marginal
cost of supplying it.
C) the quantity of apartments supplied has decreased.
D) All of the above.
Answer: A
Diff: 1
Topic: Policies that Create a Wedge
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Chapter 9/Applying the Competitive Model
26) Figure 9.2 shows supply and demand curves for apartment units in a large city. If the city
government passes a law that establishes $350 per month as the legal maximum rent, the
consumer's net gain in surplus equals
A) c - f.
B) b - f.
C) d - f.
D) Answer cannot be determined from the information given.
Answer: A
Diff: 1
Topic: Policies that Create a Wedge
27) Figure 9.2 shows supply and demand curves for apartment units in a large city. If the city
government passes a law that establishes $350 per month as the legal maximum rent,
producer surplus
A) increases.
B) decreases.
C) stays the same.
D) changes in a direction that cannot be determined from the information given.
Answer: B
Diff: 1
Topic: Policies that Create a Wedge
28) Figure 9.2 shows supply and demand curves for apartment units in a large city. If the city
government passes a law that establishes $350 per month as the legal maximum rent,
producer surplus decreases by
A) d.
B) b + f.
C) c + g.
D) i.
Answer: C
Diff: 1
Topic: Policies that Create a Wedge
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Chapter 9/Applying the Competitive Model
29) Figure 9.2 shows supply and demand curves for apartment units in a large city. If the city
government passes a law that establishes $350 per month as the legal maximum rent,
producer surplus will be
A) d.
B) d + e.
C) d + g.
D) d + c + g.
Answer: A
Diff: 1
Topic: Policies that Create a Wedge
30) Figure 9.2 shows supply and demand curves for apartment units in a large city. At the
unregulated equilibrium, producer surplus will be
A) d.
B) d + e.
C) d + g.
D) d + c + g.
Answer: D
Diff: 1
Topic: Policies that Create a Wedge
31) Figure 9.2 shows supply and demand curves for apartment units in a large city. The area "e"
represents
A) the loss in producer surplus if a rent ceiling of $350 is imposed.
B) the total variable cost of supplying Q1 units.
C) the marginal cost of supplying Q1 units.
D) the total revenue received by supplying Q1 units.
Answer: B
Diff: 1
Topic: Policies that Create a Wedge
32) Figure 9.2 shows supply and demand curves for apartment units in a large city. The area "c"
represents
A) the loss in consumer surplus if a rent ceiling of $350 is imposed.
B) a transfer from producers to consumers if a rent ceiling of $350 is imposed.
C) a transfer from consumers to producers if a rent ceiling of $350 is imposed.
D) the total revenue received by supplying Q1 units.
Answer: B
Diff: 1
Topic: Policies that Create a Wedge
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Chapter 9/Applying the Competitive Model
Figure 9.3
33) Figure 9.3 shows supply and demand curves for milk. In an effort to help farmers, the
government passes a law that establishes a $3 per gallon price support. To maintain the price
support, government expenditures must equal
A) k + i.
B) f + g + h + i + j.
C) f + g + h + i + j + k.
D) f + g + h + i + j + k + e.
Answer: C
Diff: 1
Topic: Policies that Create a Wedge
34) Figure 9.3 shows supply and demand curves for milk. In an effort to help farmers, the
government passes a law that establishes a $3 per gallon price support. To maintain the price
support, government must purchase
A) Q1 gallons.
B) Q2 gallons.
C) Q1-Q2 gallons.
D) Q2-Q1 gallons.
Answer: D
Diff: 1
Topic: Policies that Create a Wedge
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Chapter 9/Applying the Competitive Model
35) Figure 9.3 shows supply and demand curves for milk. In an effort to help farmers, the
government passes a law that establishes a $3 per gallon price support. As a result, consumer
surplus falls by
A) a.
B) b + f.
C) f + g.
D) b + f - c.
Answer: B
Diff: 1
Topic: Policies that Create a Wedge
36) Figure 9.3 shows supply and demand curves for milk. In an effort to help farmers, the
government passes a law that establishes a $3 per gallon price support. The loss in social
welfare resulting from this price support equals
A) k + i.
B) j.
C) [$3 * (Q2- Q1)] - h.
D) $3 * k.
Answer: C
Diff: 1
Topic: Policies that Create a Wedge
37) Figure 9.3 shows supply and demand curves for milk. If the government passes a $2 per
gallon specific tax, the loss in social welfare will equal
A) b + c + f + g.
B) f + g.
C) b + f.
D) c + g.
Answer: B
Diff: 1
Topic: Policies that Create a Wedge
38) Figure 9.3 shows supply and demand curves for milk. If the government passes a $2 per
gallon specific tax, the loss in consumer surplus will equal
A) b + c + f + g.
B) f + g.
C) b + f.
D) c + g.
Answer: C
Diff: 1
Topic: Policies that Create a Wedge
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Chapter 9/Applying the Competitive Model
39) Figure 9.3 shows supply and demand curves for milk. If the government passes a $2 per
gallon specific tax, the loss in producer surplus will equal
A) b + c + f + g.
B) f + g.
C) b + f.
D) c + g.
Answer: D
Diff: 1
Topic: Policies that Create a Wedge
40) Figure 9.3 shows supply and demand curves for milk. If the government passes a $2 per
gallon specific tax, the tax revenue is
A) $2 * Q1.
B) $2 * Q2.
C) $2 *(Q2 - Q1).
D) $2.
Answer: A
Diff: 1
Topic: Policies that Create a Wedge
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Chapter 9/Applying the Competitive Model
Figure 9.4
41) Figure 9.4 shows the market for rice in Japan. S2 represents the domestic supply curve, and
S1 represents the world supply curve. If imported rice is banned, the loss in social welfare is
A) a + b + c + d + e.
B) a.
C) c + e.
D) a + c + d + e.
Answer: D
Diff: 1
Topic: Comparing Both Types of Policies
42) Figure 9.4 shows the market for rice in Japan. S2 represents the domestic supply curve, and
S1 represents the world supply curve. If a $1 tariff is imposed on imported rice, the loss in
social welfare is
A) b + c + d + e.
B) a.
C) c + e.
D) a + c + d + e.
Answer: C
Diff: 1
Topic: Comparing Both Types of Policies
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Chapter 9/Applying the Competitive Model
43) Figure 9.4 shows the market for rice in Japan. S2 represents the domestic supply curve, and
S1 represents the world supply curve. Suppose a free market exists. If a $1 per unit tariff is
imposed on imported rice, the quantity of imported rice will decrease by
A) 10 units.
B) 20 units.
C) 30 units.
D) 40 units.
Answer: B
Diff: 2
Topic: Comparing Both Types of Policies
44) Figure 9.4 shows the market for rice in Japan. S2 represents the domestic supply curve, and
S1 represents the world supply curve. Suppose a free market exists. An import quota of 30
units would
A) cause consumer surplus to fall by "e".
B) cause social welfare to fall by $30.
C) increase producer surplus by "d".
D) have no effect.
Answer: D
Diff: 2
Topic: Comparing Both Types of Policies
45) Figure 9.4 shows the market for rice in Japan. S2 represents the domestic supply curve, and
S1 represents the world supply curve. Suppose a free market exists. The smallest tariff
necessary to completely eliminate imported rice is
A) $1 per unit.
B) $2 per unit.
C) $3 per unit.
D) $4 per unit.
Answer: B
Diff: 2
Topic: Comparing Both Types of Policies
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Chapter 9/Applying the Competitive Model
46) Figure 9.4 shows the market for rice in Japan. S2 represents the domestic supply curve, and S1
represents the world supply curve. A $1 per unit tariff has the same effect on producer and
consumer surplus as a quota of
A) 10 units.
B) 20 units.
C) 30 units.
D) 40 units.
Answer: A
Diff: 2
Topic: Comparing Both Types of Policies
47) Tariffs and quotas create a loss in social welfare because
A) producer surplus declines.
B) revenues from tariffs are misspent.
C) consumer surplus declines.
D) All of the above.
Answer: C
Diff: 1
Topic: Comparing Both Types of Policies
48) The welfare loss from an import quota is greater than that of an equivalent tariff because
A) tariff revenues can be used to society's benefit.
B) the loss in consumer surplus is not as large.
C) domestic producers gain more from a quota than from a tariff.
D) tariff revenues represent an additional deadweight loss.
Answer: A
Diff: 1
Topic: Comparing Both Types of Policies
49) The cost of lobbying for an import quota in a perfectly competitive market
A) increases the welfare loss of the quota.
B) decreases the deadweight loss of the quota.
C) shifts the supply curve of the good to the left.
D) increases the consumer surplus.
Answer: A
Diff: 1
Topic: Comparing Both Types of Policies
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Chapter 9/Applying the Competitive Model
TRUE/FALSE/EXPLAIN QUESTIONS
1) Consumer surplus from a given purchase is the difference between what one was willing to
pay for that purchase and what was actually paid.
Answer: True. This is the definition of consumer surplus.
Diff: 1
Topic: Consumer Welfare
2) Consumers who are more sensitive to changes in price suffer a greater loss of consumer
surplus from any given price increase.
Answer: False. Consumers who are more sensitive to the price increase will reduce their
purchase of the good by a greater extent than those who are not price sensitive. As a result,
they incur a smaller loss of consumer surplus.
Diff: 2
Topic: Consumer Welfare
3) Producer surplus is the sum of the profits earned by all firms in a market.
Answer: False. This definition ignores fixed costs. Producer surplus minus fixed costs equals
profits.
Diff: 1
Topic: Producer Welfare
4) As the quantity produced of a good increases, the social welfare generated by that good
increases.
Answer: False. This only takes consumer surplus into account. Beyond the competitive
equilibrium, additional units of output have less value than the cost to make them. Thus,
beyond the competitive equilibrium, social welfare declines as the quantity of a good
increases.
Diff: 1
Topic: Competition Maximizes Welfare
5) Policies that restrict supply could generate an increase in social welfare because the increase
in producer surplus could exceed the decrease in consumer surplus.
Answer: False. One impact of a supply restriction is an exchange from consumers to
producers. The net effect on social welfare is zero. Additionally, there is a deadweight loss.
This is the additional surplus that could be generated if supply were not restricted. This effect
is always negative. As a result, social welfare always declines in response to a supply
restriction.
Diff: 2
Topic: Policies that Shift Supply Curves
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Chapter 9/Applying the Competitive Model
PROBLEMS
Figure 9.5
1) Ann and Bill each spend $30 per month on cigarettes when the price is $1 per pack. Draw a
graph to illustrate that the consumer with the less elastic demand will suffer the greater loss
of consumer surplus when the price of cigarettes increases. Explain and label the figure.
Answer: See Figure 9.5. The curve labeled LE is the less elastic demand curve, and the curve
labeled ME is the more elastic demand curve. When price increases from $1 to pn, the person
with demand curve ME suffers a loss of a+c+e. The person with demand curve LE suffers a
loss of a+b+c+d+e. Thus, the person with the less elastic demand suffers the greater loss of
consumer surplus.
Diff: 1
Topic: Consumer Welfare
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Chapter 9/Applying the Competitive Model
Figure 9.6
2) Figure 9.6 shows an individual's demand curve for time per month spent telecommunicating
while driving (talking on the car phone.) A car phone is useless except for talking with
somebody who is not in the car. If calls are priced at ten cents per minute, what is the
consumer surplus derived from talking? What is the most this person would pay for the car
phone? Explain.
Answer: The consumer surplus from talking on the car phone is ($2.90 * 20)/2 = $29. This
person would pay up to $29 per month to have the phone. Having the phone is worth $29 per
month to this person because that is value this person places on calls from the car phone over
and above what is paid just for the calls. The phone has no other value to the person except to
make the calls. If the phone cost more than $29 per month this person would feel better off
without the phone.
Diff: 2
Topic: Consumer Welfare
3) When is the profit a firm earns equal to the producer surplus? Explain.
Answer: Profit equals producer surplus when the firm has no fixed costs. Producer surplus
can be thought of as the gains from trade. In the short run, if the firm produces any output, it
earns profit equal to revenue minus variable costs minus fixed costs. If the firm shuts down,
it loses the fixed costs. The producer surplus equals the profit from trading minus the profit
or loss from not trading, revenue minus variable costs. If no fixed costs exist, then profit will
equal the producer surplus.
Diff: 1
Topic: Producer Welfare
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Chapter 9/Applying the Competitive Model
Figure 9.7
4) Suppose the market supply curve for wheat is shown in Figure 9.7. Calculate the producer
surplus when price is $2 per bushel. If legislation mandates that the price be $1 per bushel,
what is the resulting loss in producer surplus?
Answer: At a price of $2, producer surplus equals ($1.50 * 1200)/2 = $900. At a price of $1,
producer surplus equals ($0.50 * 500)/2 = $125. The $1 decrease in prices results in a $775
decrease in producer surplus.
Diff: 1
Topic: Producer Welfare
5) Explain why the competitive output maximizes welfare.
Answer: If less output is produced, then the last unit that is consumed will be valued by
consumers more than the cost of producing it. If output is increased to the competitive level,
consumers would value those additional goods more than the cost of producing them, and
welfare would increase. If output is greater than the competitive output level, then the cost of
producing the units beyond the competitive level is greater than the value. At output levels
greater than the competitive level welfare is decreased. Thus, the competitive output level
maximizes welfare, because consumers value the last unit of output at exactly the amount
that it costs to produce it.
Diff: 1
Topic: Competition Maximizes Welfare
6) Suppose a consumer advocacy group has convinced legislators that vitamin pills should be
free to consumers. Such a policy would enhance the health of the citizenry, they argue.
Assuming a downward-sloping linear demand curve and a horizontal long-run supply curve,
determine the resulting output and social welfare from such a policy. Compare this result to
the competitive equilibrium.
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Chapter 9/Applying the Competitive Model
Answer: Consumer surplus is maximized when price equals zero. Output will be the quantity
where the demand curve hits the quantity axis. The social welfare is less than the competitive
result because for quantities beyond the competitive equilibrium, producers incur a cost for
which they are not reimbursed. Some of this loss represents a transfer to consumers (the area
under the demand curve to the right of the equilibrium quantity). The area above the demand
curve and below the supply curve for quantities beyond the equilibrium quantity represents
the deadweight loss.
Diff: 2
Topic: Competition Maximizes Welfare
7) Suppose an industry trade group has convinced legislators that a price floor should be used so
that producer surplus is maximized in the market for milk. The group argues that such a
policy would save the "family farm." Assuming a downward-sloping linear demand curve
and a horizontal long-run supply curve, determine the resulting price, output and social
welfare from such a policy. Compare this result to the competitive equilibrium.
Answer: Producer surplus is maximized at a price that is midway between the supply curve
and the demand curve intercept. Compared to the competitive equilibrium, a lower quantity
is sold at a higher price. The area from this new quantity to the competitive quantity in
between the demand and supply curves represents the loss of consumer surplus that is not
gained by anyone—the deadweight loss.
Diff: 2
Topic: Competition Maximizes Welfare
8) Suppose anyone with a driver's license is capable of supplying one trip from the airport to the
downtown business center on any given day. The long-run supply curve of such trips is
horizontal at p = $50, which is the average cost of such trips. Suppose daily demand is Q =
1000 - 10p. Calculate the change in consumer surplus, producer surplus and social welfare if
the city government requires those people supplying such trips to possess a special license,
and the government will issue only 300 licenses.
Answer: The competitive equilibrium is Q = 1000 - (10 * 50) = 500. With the supply
restriction of 300, price becomes $70. The loss in social welfare is [(70 - 50) * (500 - 300)]/2
= $2,000. Producers gain (70 - 50) * 300 = $6,000. Consumers lose $6,000 + $2,000 =
$8,000.
Diff: 2
Topic: Policies that Shift Supply Curves
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Chapter 9/Applying the Competitive Model
Figure 9.8
9) Figure 9.8 shows the demand and supply curves in the market for milk. Currently the market
is in equilibrium. If the government imposes a $2 per gallon tax to be collected from sellers,
estimate the change in p, Q, and social welfare.
Answer: The supply curve shifts vertically by $2. The price changes from $3 per gallon to $4
per gallon. Quantity falls from 1,000 gallons to 500 gallons. For the 500 gallons no longer
produced, consumer surplus was$250 and producer surplus was $250. Producers and
consumers lose $1,000 but that represents a transfer to government.
Diff: 2
Topic: Policies that Create a Wedge
10) Figure 9.8 shows the demand and supply curves in the market for milk. Currently, the
market is in equilibrium. If the government imposes a $2 per gallon tax to be collected from
sellers, calculate the dead weight loss associated with the tax, and explain why the dead
weight loss occurs.
Answer: The deadweight loss equals .5*2*500 = $500. The deadweight loss occurs because
the tax lowers the output from the competitive level. At the output level that occurs with the
tax, consumers value the last unit of output by more than it costs to
produce that unit.
Diff: 1
Topic: Policies that Create a Wedge
11) Figure 9.8 shows the demand and supply curves in the market for milk. Currently the market
is in equilibrium. If the government establishes a $4 per gallon price support, estimate the
change in p, Q, and social welfare.
Answer: Price rises to $4 per gallon. Consumers purchase only 500 gallons of milk.
Government purchases 1,000 gallons of milk to support the price at $4. Thus, a total of 1,500
gallons is produced. The loss in social welfare equals (1000 gallons of milk at $4/gallon
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Chapter 9/Applying the Competitive Model
equals $4,000) less the producer surplus above the old demand curve up to a price of $4
(which is $500). The loss in social welfare is $3,500.
Diff: 2
Topic: Policies that Create a Wedge
12) Figure 9.8 shows the demand and supply curves in the market for milk. Currently the market
is in equilibrium. If the government establishes a $2 per gallon price ceiling to ensure that
children are nourished, estimate the change in p, Q, and social welfare.
Answer: At a price of $2, only 500 gallons are produced. The deadweight loss equals [(1000
- 500) * (4 - 2)]/2 =$500.
Diff: 2
Topic: Policies that Create a Wedge
13) "Supporters of import restrictions and protectionist policies place greater weight on producer
welfare than on consumer welfare." Comment.
Answer: Import restrictions increase the producer surplus of domestic producers. Consumer
surplus, however, decreases by more than producers gain. Thus, the statement seems to be
correct.
Diff: 1
Topic: Comparing Both Types of Policies
Figure 9.9
14) The domestic demand curve, domestic supply curve, and world supply curves for a
good are given in Figure 9.9. All the curves are linear. Initially, the country allows imports.
Then imports are banned. Calculate how consumer and producer surplus change because of
the ban. Is the country better off with the ban on imports? Why?
Answer: Consumer surplus before the ban equals .5*80*75 = $3000. Producer surplus
before the ban equals .5*20*10 = $1000. Total social welfare equals $4000. The consumer
surplus after the ban equals .5*50*50 = $1250. Producer surplus equals .5*50*50 = $1250
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after the ban. Total social welfare equals $2500. Consumer surplus has decreased by $1750
and producer surplus has increased by $250 because of the ban. Total social welfare has
decreased by $1500. The country is worse off because the total social welfare has decreased.
Diff: 2
Topic: Comparing Both Types of Policies
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