Principles of Microeconomics (Econ 2)
Drake University, Summer 2005
William M. Boal
Signature:
Printed name:
QUIZ #5
“Market Controls, Taxes, and Subsidies”
INSTRUCTIONS: This exam is closed-book, closed-notes. Simple calculators are permitted, but graphing calculators or
calculators with alphabetical keyboards are NOT permitted. Numerical answers, if rounded, must be correct to at least 3
significant digits. Point values for each question are noted in brackets. Maximum total points are 100.
I. Multiple choice: Circle the one best answer to each question. [3pts each: 31 pts total]
(1) If a price ceiling (or legal maximum price) on baby
formula were binding, it would create
a. excess demand for baby formula.
b. excess supply of baby formula.
c. a surplus of baby formula.
d. an increase in quantity of wheat supplied.
(2) Who loses if a price floor (or legal minimum price) is
imposed on taxicab rides?
a. All customers of taxicabs.
b. All proprietors oftaxicabs (i.e., sellers of taxicab
rides).
c. All customers and proprietors of taxicabs.
d. No one loses—everyone gains.
(6) If the tax rate on wages is increased, the tax revenues
collected by the government
a. necessarily decrease.
b. necessarily increase.
c. remain constant.
d. increase or decrease, depending on the shapes of the
demand and supply curves for labor.
(7) The total price received by sellers of textbooks would
be greater than the net price paid by buyers of textbooks
if the government imposed a
a. price ceiling (or legal maximum price) on textbooks.
b. price floor (or legal minimum price) on textbooks.
c. subsidy for textbooks.
d. tax on textbooks.
(3) A quota on buyers of gasoline, if binding, will cause
the price of gasoline to
a. rise.
b. fall.
c. remain constant.
d. rise or fall, depending on the shapes of the demand
and supply curves for gasoline.
(8) Suppose the supply of milk were perfectly elastic. If
a tax were placed on milk,
a. buyers would pay all of the tax.
b. buyers would pay most of the tax.
c. sellers would pay all of the tax.
d. sellers would pay most of the tax.
(4) The price of propane will increase if the government
imposes
a. a price ceiling (or legal maximum price) for
propane.
b. a quota on sellers of propane.
c. a quota on buyers of propane.
d. any of the above.
(9) The amount of bicycle helmets actually sold would
increase if the government imposed a
a. price floor (or legal minimum price) on bicycle
helmets.
b. quota on bicycle helmets.
c. tax on bicycle helmets.
d. subsidy for bicycle helmets.
(5) Suppose the price elasticity of demand for computers
is -0.2 and the price elasticity of supply of computers is
8.0. If a tax is imposed on computers, which side of the
market effectively pays most of the tax?
a. Sellers.
b. Buyers.
c. Sellers and buyers each pay half of the tax.
d. Answer depends on which side is legally required to
remit the tax to the government.
(10) The amount of peanuts actually sold would decrease
if the government imposed
a. a quota on peanuts.
b. a price floor (or legal minimum price) for peanuts.
c. a price ceiling (or legal maximum price) on peanuts.
d. all of the above.
Principles of Microeconomics (Econ 2)
Drake University, Summer 2005
Quiz 5
Page 2 of 6
(11) Suppose currently 200,000 people in Iowa have
internet access. If the government paid a subsidy of $5
per month for internet access, the direct cost of the
subsidy program to the government would be
a. $1 million per month.
b. more than $1 million per month.
c. less than $1 million per month.
d. cannot be determined from information given
II. Problems: Insert your answer to each question below in the box provided. Feel free to use the margins for scratch
workonly the answers in the boxes will be graded. Work carefullypartial credit is not normally given for questions in
this section.
(1) [Price controls: 12 pts] The following graph shows the market for apple juice. Suppose a price ceiling (or legal
maximum price) of $3 is imposed on this market. No apple juice may be sold for more than $3.
$10
$9
Price per gallon
$8
$7
$6
Demand
$5
Supply
$4
$3
$2
$1
$0
0
1
2
3
4
5
6
7
8
9
10
Millions of gallons
a. Is this price ceiling binding or nonbinding?
b. Find the quantity of quantity of apple juice actually sold with this price
ceiling.
c. Will this price ceiling result in excess demand or excess supply of apple
juice?
d. How much?
million gallons
million gallons
Principles of Microeconomics (Econ 2)
Drake University, Summer 2005
Quiz 5
Page 3 of 6
(2) [Quotas: 12 pts] Suppose the government discovers that a particular chemical contributes to global warming. To
control use of the chemical, the government has decided to impose a quota of 4 thousand liters. The market for the
chemical is shown in the graph below.
$13
$12
$11
$10
Price per liter
$9
$8
$7
Demand
$6
Supply
$5
$4
$3
$2
$1
$0
0
1
2
3
4
5
6
7
8
9
10 11
12
13
Thousands of liters
First suppose the quota is imposed on producers. Four thousand permits to sell one liter of the chemical are distributed to
producers of the chemical.
a. What will be the equilibrium price of the chemical with the quota?
$
per liter
b. If the government sells the permits to producers at auction, or allows
permits to be traded, what price will be the equilibrium price of a permit?
$
per permit
Alternatively, suppose the quota is imposed on consumers. Four thousand permits to buy one liter of the chemical are
distributed to consumers of the chemical.
c. What will be the equilibrium price of the chemical with the quota?
$
per liter
d. If the government sells the permits to consumers at auction, or allows
permits to be traded, what price will be the equilibrium price of a permit?
$
per permit
Principles of Microeconomics (Econ 2)
Drake University, Summer 2005
Quiz 5
Page 4 of 6
Buyer
Art
Betty
Carl
Darla
Evan
Felicia
Value
$14
$10
$ 8
$ 8
$ 7
$ 5
Seller
Gary
Helen
Ian
Jill
Kevin
Laura
$15
$14
$13
$12
$11
$10
Price
(3) [Tax: 15 pts] Suppose six buyers and six sellers
engage in a market similar to the exercise we did in
class. Each buyer may buy at most one unit and each
seller may sell at most one unit, but no one is forced to
trade. Assume that buyers and sellers are each trying to
maximize their personal earnings (or “gains from trade”).
Earnings for each buyer equal the buyer's value of the
good minus the price paid. Earnings for each seller equal
the price received minus the seller's cost of the good.
Earnings of persons who do not trade are zero. Buyers’
values and sellers’ costs are given in the following table.
$9
$8
$7
$6
$5
$4
Cost
$ 1
$ 2
$ 4
$ 5
$ 5
$ 7
$3
$2
$1
$0
0
1
2
3
4
5
6
7
8
Quantity
You can use the graph at right for scratch work.
Suppose with some experience, the market settles on a single price. All trades are made at that price.
a. What is that single price likely to be? Give an answer to the nearest whole dollar.
$
b. How many units of the good will be sold in this market?
units
Now suppose a tax of $6 per unit is imposed on buyers. All buyers must pay this tax if they buy the good. (If they do not
buy the good, they owe no tax.) Consider the new equilibrium.
c. What is the net price received by sellers (excluding the tax) likely to be? Give an answer to
$
the nearest whole dollar.
d. What is the total price paid by buyers (including the tax) likely to be? Give an answer to the $
nearest whole dollar.
e. How many units of the good will be sold in this market?
units
(4) [Laffer curve: 12 pts] The graph below shows the
market for watermelons. Calculate the tax revenue
collected by the government if watemelons are taxed at
the following rates:
b. $4 per watermelon
c. $6 per watermelon
d. $8 per watermelon
Supply
$9
$8
Tax revenue
$
$
$
$
Demand
$10
thousand
thousand
thousand
thousand
$7
Price
Tax rate
a. $2 per watermelon
$11
$6
$5
$4
$3
$2
$1
$0
0
1
2
3
4
5
Quantity (thousands)
6
7
Principles of Microeconomics (Econ 2)
Drake University, Summer 2005
Quiz 5
Page 5 of 6
(5) [Subsidies: 12 pts] Suppose the market for infant car seats is described by the curves graphed below.
$70
$65
Price
$60
$55
$50
$45
$40
Demand
$35
$30
Supply
$25
$20
$15
$10
$5
$0
0
1
2
3
4
5
6
7
8
9
10 11 12 13 14
Quantity (thousands)
Suppose the government offers a subsidy of $15 per infant car seat.
a. Compute the equilibrium number of infant car seats that will be sold.
b. Compute the equilibrium net price of an infant car seat paid by buyers (excluding
the subsidy).
c. Compute the equilibrium total price of an infant car seat received by sellers
(including the subsidy).
d. Compute the direct cost of the subsidy program to the government. In other words,
how much should the government budget for subsidy payments?
thousand
$
$
$
thousand
Principles of Microeconomics (Econ 2)
Drake University, Summer 2005
Quiz 5
Page 6 of 6
III. Critical thinking: Answer all parts of the question below. Full credit requires correct economic reasoning, legible
writing, good grammar including complete sentences, and accurate spelling. [4 pts]
(1) Suppose Ann's old car is worth $2000 to Ann, but it would be worth $2500 to Adam, who especially likes this
particular model.
a.
Will Ann and Adam likely be able to reach an agreement on selling the car? Why or why not?
Now suppose there is a $600 tax on selling used cars.
b.
Explain why Ann and Adam will no longer be able to reach an agreement on selling the car.
c.
Since Ann does not sell the car, obviously neither person will pay any tax. But did the tax still cost them anything? If
not, explain why not. If the tax did cost them something, explain why and compute the amount.
[end of quiz]