Answers to in-text Questions in Economics (5th ed)
Chapter 3
Page
64  Draw a supply and demand diagram with the price of labour (the wage rate) on the vertical axis and the
quantity of labour (the number of workers) on the horizontal axis. What will happen to employment if the
government raises wages from the equilibrium to some minimum wage above the equilibrium?
The diagram will look like Figure 3.1 in the text. Employment will fall to Qd workers. The supply of
workers will rise to Qs. There will thus be unemployment (a surplus of workers) of Qs minus Qd.
65
 (Box 3.1) 1. How could housing supplied by the public sector be made to rectify some of the problems we
have identified above? (What would it do to the supply curve?)
It would shift the supply of rental accommodation to the right, and thereby reduce the free-market rent; or
it would reduce the shortage of accommodation in the case where rents are fixed below the equilibrium.
 (Box 3.1) 2. If the government gives poor people rent allowances (i.e. grants), how will this affect the level
of rents in an uncontrolled market?
They will increase (the demand for rented accommodation will increase).
 (Box 3.1) 3. The case for and against rent controls depends to a large extent on the long-run elasticity of
supply. Do you think it will be relatively elastic or inelastic? Give reasons.
Relatively elastic. Below a certain rent, it will not be worth the owners incurring the costs and time of
renting out the accommodation. The solution, therefore, to cheap affordable accommodation is to tackle
the supply directly: either by public housing or by subsidising or giving tax relief to the private sector.
66
 (Box 3.2) 1. What would be the effect on black-market prices of a rise in the official price?
Other things being equal, there would probably be a fall in the black-market price. A rise in the official
price would cause an increase in the quantity supplied and a reduction in the quantity demanded and hence
less of a shortage. There would therefore be less demand for black-market products.
 (Box 3.2) 2. Will a system of low official prices plus a black market be more equitable or less equitable
than a system of free markets?
More equitable if the supplies at official prices were distributed fairly (e.g. by some form of rationing). If,
however, supplies were allocated on a first-come, first-served basis, then on official markets there would
still be inequity between those who are lucky enough or queue long enough to get the product and those
who do not get it. Also, the rich will still be able to get the product on the black market!
 Think of some examples where the price of a good or service is kept below the equilibrium (e.g. rent
controls). In each case consider the advantages and disadvantages of the policy.
Two examples are:
•
Rent controls. Advantages: makes cheap housing available to those who would otherwise have
difficulty in affording reasonable accommodation. Disadvantages: causes a reduction in the supply of
private rented accommodation; causes demand to exceed supply and thus some people will be unable
to find accommodation.
•
Tickets for a concert. Advantages: allows the price to be advertised in advance and guarantees a full
house; makes seats available to those who could not afford the free-market price. Disadvantages:
causes queuing or seats being only available to those booking well in advance.
Answers to questions in Economics (5th edition) by John Sloman
Page
68  Supply tends to be more elastic in the long run than in the short run. Assume that a tax is imposed on a
good that was previously untaxed. How will the incidence of this tax change as time passes? How will
the incidence be affected if demand too becomes more elastic over time?
As supply becomes more elastic, so output will fall and hence tax revenue will fall. At the same time price
will tend to rise and hence the incidence will shift from the producer to the consumer. The situation will
move from being more like case (3) to more like case (4) in Figure 3.5 in the text.
As demand becomes more elastic, so this too will lead to a fall in sales. This, however, will have the
opposite effect on the incidence of the tax: the burden will tend to shift from the consumer to the producer.
The situation will move from being more like case (1) to more like case (2) in Figure 3.5.
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 (Box 3.3) 1. If raising the tax rate on cigarettes both raises more revenue and reduces smoking, is there
any conflict between the health and revenue objectives of the government?
There may still be a dilemma in terms of the amount by which the tax rate should be raised. To raise the
maximum amount of revenue may require only a relatively modest increase in the tax rate. To obtain a
large reduction in smoking, however, may require a very large increase in the tax rate. Ultimately, if the
tax rate were to be so high as to stop people smoking altogether, there would be no tax revenue at all for
the government!
 (Box 3.3) 2. You are a government minister; what arguments might you put forward in favour of
maximising the revenue from cigarette taxation?
That it is better than putting the taxes on more socially desirable activities. That there is the beneficial
spin-off from reducing a harmful activity. (You would conveniently ignore the option of putting up taxes
beyond the point that maximises revenue and thus cutting down even more on smoking.)
 (Box 3.3) 3. You are a doctor; why might you suggest that smoking should be severely restricted? What
methods would you advocate?
That the medical arguments concerning damage to health should take precedence over questions of raising
revenue. You would probably advocate using whatever method was most effective in reducing smoking.
This would probably include a series of measures from large increases in taxes, to banning advertising, to
education campaigns against smoking. You might even go so far as to advocate making smoking tobacco
illegal. The problem here, of course, would be in policing the law.
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 Schooling is free in state schools in most countries. If parents are given a choice of schools for their
children, there will be a shortage of places at popular schools (the analysis will be the same as in Figures
3.6, with the number of places in a given school measured on the horizontal axis). What methods could be
used for dealing with this shortage? What are their relative merits?
Some form of rationing (selection) will have to be applied. This could be done on the basis of ability. If
the objective is to have schools that cater for the full range of abilities, then this objective will not be met.
If the objective is to recruit the most able children, then selection by ability is consistent with this goal. An
alternative is to select by geographical location, with the students living nearer to the school being given
preference over those living further away. This is the system used by most state primary and
comprehensive schools. It could well disadvantage children with particular needs, however, for whom the
school would be particularly suitable. It can also lead to the development of ‘ghetto’ schools in deprived
areas, especially if schools rely for part of their funding on parental contributions. Other methods include
the ‘sibling’ rule, whereby children who have older brothers or sisters already at the school are given
preference. This, however, could lead to children living nearer the school being deprived of a place.
71
 Under what circumstances would making a product illegal (a) cause as fall in its price; (b) cause the
quantity sold to fall to zero.
(a) Where the shift in demand was greater than the shift in supply (perhaps because of very ‘law abiding’
consumers, or where consumers faced harsher penalties than suppliers.
(b) Where the penalties were very harsh and the law was strictly enforced, and/or where people were very
law abiding.
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Chapter 3
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71  What are the arguments for and against making the sale of alcoholic drinks illegal? To what extent can
an economist help to resolve the issue?
Clearly this involves making normative judgements about how far people should be free to choose their
own lifestyle and how much the state has a responsibility for controlling people’s behaviour that adversely
affects other people (or themselves). Benefits of making alcoholic drinks illegal include: a reduction in
road accidents and other drink-related accidents; a reduction in drink-related illnesses (and a saving to the
nation’s health budget); a reduction in drink-related anti-social behaviour; more money available to
children and other family members in families where there are one or more drinkers. Disadvantages
include: curbing an activity that gives many people pleasure; limiting human freedom (freedom to choose
what to do, rather than freedom from having to suffer other people’s drunken behaviour); problems of
enforcing the law; encouraging the development of criminal activity and the development of an illegal
drink ‘underworld’ (as occurred during the Prohibition in the USA); preventing responsible, moderate
drinking (which can have health benefits).
Economists can contribute to the debate by identifying the costs and benefits and measuring many of
them (such as the money saved on treating road casualties in drink-related accidents). They cannot,
however, make the final moral judgements, since the weighting that should be attached to the costs and
benefits is a normative issue.
72
 Why is the supply curve drawn as a vertical straight line in Figure 3.8?
Because, in the short run, the supply of food is virtually fixed. Once a crop is grown and harvested, then it
is of a fixed amount. (In practice, the timing of releasing crops on to the market can vary, given that many
crops can be stored. This does allow some variation of supply with price.)
 Why don’t farmers benefit from a high income elasticity of demand for convenience foods?
Because most of the increased expenditure goes on value added in the processing, not on the basic food
content. Thus it is the food processors who get the benefit, not the farmers.
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 (Box 3.4) 1. The income elasticity of demand for milk is negative (an ‘inferior’ good). What is the
implication of this for milk producers?
Milk producers would expect to earn less as time goes past, given that national income rises over time.
Thus if the incomes of individual milk producers are to be protected, production should be reduced (with
some dairy farmers switching to other foodstuffs or away from food production altogether).
 (Box 3.4) 2. Why do pork and lamb have relatively high price elasticities of demand compared with the
other foodstuffs in the table? What are the implications of this for the relative stability or instability of the
prices of pork and lamb compared with other foodstuffs?
They have relatively high price elasticities of demand because they are relatively close substitutes for each
other and for other meats. Shifts in supply of a particular meat will have a relatively small effect on price.
This suggests that their prices would be more stable than those of other broader categories of foodstuff,
assuming similar variations in supply. If the supply of all meats are affected, however, there will be a
greater effect on the price of each of the meats, since the demand for meat as a whole (as opposed to a
particular type of meat) is relatively price inelastic.
If, however, we compare them with narrower categories of other foodstuffs (e.g. a particular type of
vegetable), which therefore themselves have more substitutes and hence have a higher price elasticity of
demand, then the prices of the meats might not expected to be more stable. If, however, particular crops
vary more in supply than the output of particular meats, then the price of meats would be more stable, even
if the price elasticity of demand were no different from that of particular crops.
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 (Box 3.5) 1. Can you think of any other (non-farming) examples of the fallacy of composition?
Two examples are:
•
People standing to get a better view at a concert. When one person does this, then that person will get
a better view. When everyone does it, there is no gain. In fact, there is a net loss, because people
would presumably prefer to sit than stand!
3
Answers to questions in Economics (5th edition) by John Sloman
Page
74
•
If one person gets a pay increase 5 per cent above the current rate of inflation, he or she will be 5 per
cent better off (assuming no change in the rate of inflation). If everyone gets a pay increase 5 per cent
above the current rate of inflation, then that will drive the rate of inflation up. People will not be 5 per
cent better off.
 (Box 3.5) 2. Would the above arguments apply in the case of foodstuffs that can be imported as well as
being produced at home?
In the case of a foodstuff that can be imported, the demand curve for the domestically produced foodstuff
would be more elastic (given that the imports are a substitute). Thus a good domestic harvest may only
depress the price slightly, with consumers merely switching from the imported to home-grown food. Thus
producers would gain from a good harvest (their incomes would rise if elasticity was greater than one).
If, however, the good harvest were world-wide, so that total world supply of the product increased,
then the problem would still occur if the overall demand (for home-grown plus imported food) were
inelastic.
75
 The total amount paid in subsidies is greater in Figure 3.11 than in Figure 3.12. Will it always be the
case that for a given after-subsidy price to the farmer (Pg), a greater amount will be paid out in subsidies
if the country is self-sufficient in the foodstuff than if it has to import part of the total amount consumed?
(Assume that the demand curve is the same in both cases.)
Yes. The free-market domestic price will not be above the world price. If it were (temporarily), then the
foodstuff would be imported, pushing the price back down to the world price. Thus the height of the grey
rectangle in Figure 3.11, cannot be less than that in Figure 3.12. But the width of the grey rectangle in
Figure 3.11 must be greater than that in Figure 3.12 (given that part of the demand in Figure 3.12 is
supplied from imports). Thus the area of the rectangle in Figure 3.11 must be bigger than that in Figure
3.12. Thus more is paid out in subsidy in the case where the country is self-sufficient (assuming the
demand curve is the same).
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 What will be the amount paid out in Figure 3.14 if instead of the government buying the surpluses, export
subsidies were given to farmers so as to guarantee them a price (plus subsidy) of Pmin?
The same as when the government sells the surpluses on the world market, namely the rectangle edcf.
With a guaranteed price of Pmin from exporting, farmers will produce Qs2. The farmers will therefore only
be prepared to supply domestic consumers at that same price (otherwise it would be more profitable to
export). Thus domestic consumers buy Qd2. Thus Qs2 – Qd2 is exported at a subsidy per unit of Pmin – Pw.
 Compare the relative merits of (a) quotas on output, (b) limits to the amount of land used for a particular
product and (c) farmers being required to take land out of food production.
All these methods will restrict supply and thus help to raise the free-market price and thereby eliminate (or
reduce) the need for having a minimum price above the equilibrium.
(a) Quotas have the advantage of being a direct limitation on output (as opposed to land) and will thus
lead to a more stable supply than with the other two methods. They could, however, prevent efficient
farmers expanding, unless farmers’ quotas could be sold to other farmers (as has happened with dairy
quotas in the EU).
(b) This can allow land to be reallocated to some alternative use (e.g. recreational, forestry or growing a
different crop). It could, however, lead to a lower reduction in output than planned because of less
productive land being taken out of use, rather than more productive land (although this could be seen
as an efficient use of land).
(c) This is similar to (b), but has the problem of being less focused. For example, if there is a surplus of
one particular crop, it does not make sense to prevent farmers producing other crops (which are not in
surplus) on their land. It could lead to a neglect of the land taken out of use (with problems of weeds,
etc.). On the other hand, it could help prevent the extinction of various natural species.
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Chapter 3
Page
78  Assume that the world price were above point Pe (but still below Pi). Draw a diagram to illustrate the
static costs in this case.
P
S
Pi
a
h
Pw
d
b
c
g
D
O
e
f
Q
Diagram 3.1 Static costs of high fixed prices
See Diagram 3.1. With a world price at Pw, then without intervention, the country would be a net exporter
of an amount c – b.
With an intervention price of Pi, the costs are as follows:
• Consumers lose by having to pay a higher price: i.e. Pi rather than Pw
• Farmers gain by receiving the higher price and thus earning larger profits.
• Taxpayers lose by having to finance the purchase of the surplus. This is shown by the shaded area
adef. This loss to the taxpayer could be reduced, however, to adgh if the surplus (d – a) were sold on
the world market at the world price of Pw.
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 Does the requirement to set aside 5 per cent of land reduce output by 5 per cent?
Probably not. Farmers may well attempt to increase output on their remaining land or attempt to set aside
the poorest quality land.
5