Economics for Business
Problem Set 3
Due Date: 6th December, 2005
SHORT ANSWER
1.
Using a supply-demand diagram, show a
labor market with a binding minimum
wage. Now, use the diagram to show
those who are helped by the minimum
wage, and those who are hurt by the
minimum wage.
ANSWER:
Those helped by the minimum wage are the workers who are still
employed, but now receive the higher wage. In the diagram, those would
be measured by the quantity of labor demanded at the minimum wage.
Those who are hurt by the minimum wage are those who are now
unemployed. These workers are measured as the difference between the
quantity of labor supplied and the quantity demanded at the minimum
wage. The perceptive student might note that the unemployed group can
be divided into those who lose their jobs as a result of the minimum
wage (the competitive equilibrium quantity of labor minus the quantity
demanded at the minimum wage), and those who enter the market as a
result of the higher wage, but cannot find employment (quantity of labor
supplied at the minimum wage minus the competitive equilibrium
quantity). The buyers of the labor (employers) are also worse off because
they have to pay a higher wage for labor, hence, hire a smaller quantity.
2.
a. Using the graph shown, analyze the effect a $300 price ceiling would
have on the market for ten-speed bicycles. Would this be a binding
price ceiling?
b. Using the graph shown, analyze the effect a $700 price floor would
have on this market. Would this be a binding price floor?
c. Why would policymakers choose to impose a price ceiling or price
floor?
ANSWER:
a. For this example, a $300 price ceiling would cause a shortage of 4,000
bicycles. A price ceiling is binding if it is set at any price below
equilibrium price. Since the equilibrium price in the market is $500,
this would be a binding price ceiling.
b. For this example, a $700 price floor would cause a surplus of 4,000
bicycles. A price floor is binding if it is set at any price above
equilibrium price. Since the equilibrium price in the market is $500,
this would be a binding price floor.
c. More than one reason may exist for policymakers to impose a price
ceiling or price floor in a market. Often this is done in an attempt to
increase equity.
3.
Using the graph shown, answer the following questions.
a. What was the equilibrium price in this
market before the tax?
b. What is the amount of the tax?
c. How much of the tax will the buyers
pay?
d. How much of the tax will the sellers
pay?
e. How much will the buyer pay for the
product after the tax is imposed?
f. How much will the seller receive after
the tax is imposed?
g. As a result of the tax, what has happened
to the level of market activity?
ANSWER: a. $10
b. $3
c. $1
d. $2
e. $11
f. $8
g. As a result of the tax, the level of market
activity has fallen, from 100 units being
bought and sold to only 90 units being
bought and sold.
4.
Using the graph shown, answer the following questions.
a. What was the equilibrium price in this
market before the tax?
b. What is the amount of the tax?
c. How much of the tax will the buyers
pay?
d. How much of the tax will the sellers
pay?
E. How much will the buyer pay for the
product after the tax is imposed?
F. How much will the seller receive after
the tax is imposed?
G. As a result of the tax, what has happened
to the level of market activity?
ANSWER:
a. $10.00
b. $5.00
c. $2.50
d. $2.50
e. $12.50
f. $7.50
g. As a result of the tax, the level of market activity has fallen, from 100
units being bought and sold to only 80 units being bought and sold.
5.
How does elasticity affect the burden of a tax? Justify your answer
using supply and demand diagrams.
ANSWER:
6.
The OPEC cartel has just announced cuts in production levels which are expected to drive up
the spot price of a barrel of oil by 20% in the coming weeks. Using appropriate demand and
supply diagrams, examine: 1) The impact on the retail price of petrol; 2) The likely impact
on the electricity supply market, bearing in mind that oil is an input into electricity
generation as well being a substitute source of energy.
(1) In this case, demand remains unchanged, but supply is cut. So there is a shift to the left hand of
supply curve. As a result, the price will increase and. Note that the demand for petrol is
elastic, so most of price increase will be
Fig 6.1 Demand and supply for petrol
(2). As oil is an input into the electricity market, the supply curve will shift to the left. Second, as
oil is a substitute for electricity, the increase of oil price will increase the demand for
electricity. So the demand curve will shift to the right.
P2
D2
P1
D1
Fig. 6.2 Demand and supply for electricity market
7.
Explain, using demand and supply analysis, why agricultural surpluses arise under the
European Common Agricultural Policy in which farmers receive large subsidies linked to
production levels.
A
C
D
E
F
B
G
The total surplues before subsidies is the area of AFC,the total surpluses after subsidies is the area
of AGB. It is much larger than AFC
8.
In the past few years, the price of color TV in China’s market falls quickly. This seems
puzzling given that China’s economy grows at about 9% per year. Using demand and supply
analysis to explain it.
Supply shift to right
P1
P2
D2
D1
9.
It is often claimed that the ‘free market’ leads to an economically efficient allocation of
resources – but is this allocation necessary equitable from a social welfare perspective?
Assess this question with reference to China’s housing market.
I will not give a detailed answer here, but students are required to say (1) Why a free and perfectly
competitive market will give rise to efficient allocation of resources. (2) Efficiency is
different from equity. While efficiency can be reached via perfect competitive market, equity
need not be. However, from a social welfare perspective, it is desirable to ensure the
differences between different people are not too big. (3) Some facts about China’s housing
market: price is very high. Few people can afford a reasonable house. This causes concern
over equity. There are two reasons why government should interfere. First, price is
irrationally high, i.e., there is a bubble. Second, even if there is no bubble, perhaps
government should consider providing cheap housing for those who cannot afford private
housing.
However, this answer is not meant to be complete. Students are encouraged to give their logical
analysis. The conclusion doesn’t have to be same with mine. What important is that they
understand the relationship between efficiency and equity and how the conflicts between
them may cause problem.
10. In China, there is a huge black market for train ticket. Some economists think that this is
because the rail bureau did not set the price high enough. They suggest increasing the price
to solve the problem. Do you agree with them? Suppose you are the secretary of the
transportation minister, what would you suggest him/her to do?
First of all, the reason there is a black market is that there is a shortage. Either increasing supply or
increasing price can solve the problem.
Second, it is not feasible to increase supply in short period. So if the government wants to solve
this problem, then it should not be considered. However, the government should consider
increasing supply in long run.
Third, given we cannot increase supply, it seems increasing price is the only way to solve the
shortage. This is what some economists suggested. They are right in that increase can solve the
problem theoretically.
However, the shortage is only one side of the coin. There is another side of the coin. There are
corruptions involved in China’s black ticket markets. Though sometimes there is shortage,
sometimes it is not. In many cities tickets are bought monopoly by some people related to the
ticket officer or organized interested group. Tackling corruptions or organized interest group
should greatly solve the problem.