Principles of Microeconomics (Econ 2)
Drake University, Summer 2010
William M. Boal
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QUIZ #5
“Market Controls and Taxes”
July 29, 2010
INSTRUCTIONS: This quiz 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. Use margins for scratch work. (Hint: If unsure of the
answer, sketch a graph.) [4 pts each: 32 pts total]
(1) If the free-market equilibrium price of gasoline is $3,
which government price control would be binding on the
market?
a. a price ceiling (or legal maximum price) of $2.
b. a price floor (or legal minimum price) of $2.
c. Both of the above would be binding.
d. None of the above would be binding.
(2) A quota on buying ivory would cause the price of
ivory to
a. rise.
b. fall.
c. remain constant.
d. rise or fall, depending on the shapes of the demand
and supply curves.
(3) Suppose the price elasticity of demand for hotel
rooms in a small city is -5.0 and the price elasticity of
supply is 1.5. If a tax is imposed on hotel rooms in this
city,
a. Sellers (hotel operators) will pay most of the tax.
b. Buyers (guests) will pay most of the tax.
c. Sellers and buyers will each pay half of the tax.
d. Answer depends on which side is legally required to
remit the tax to the government.
(4) New automobiles are taxed in Iowa. If the supply of
new automobiles is perfectly elastic, then who bears the
burden of the tax?
a. sellers bear all the burden of the tax.
b. sellers bear most of the burden of the tax.
c. buyers bear all the burden of the tax.
d. buyers bear most of the burden of the tax.
(5) If the tax rate on some good is gradually raised, tax
revenue received by the government will typically
a. increase steadily.
b. decrease steadily.
c. first increase and then decrease.
d. first decrease and then increase.
(6) Suppose the price elasticity of demand for hearing
aids is -1.0 and the price elasticity of supply is 5.0. If the
government offers a subsidy for hearing aids,
a. Sellers will enjoy most of the benefit.
b. Buyers will enjoy most of the benefit.
c. Sellers and buyers each enjoy half of the benefit.
d. Answer depends on which side is legally designated
to receive the subsidy check from the government.
(7) The number of payday loans actually made would
decrease if the government enacted
a. a tax on payday loans.
b. a quota on sellers (lenders) of payday loans.
c. a quota on buyers (borrowers) of payday loans.
d. an interest rate floor (or legal minimum price) for
payday loans.
e. an interest rate ceiling (or legal maximum price) on
payday loans.
f. all of the above.
g. none of the above.
(8) The number of pedometers actually sold would
increase if the government enacted a
a. a tax on pedometers.
b. a quota on sellers of pedometers.
c. a subsidy for pedometers.
d. a price floor (or legal minimum price) for
pedometers.
e. all of the above.
f. none of the above.
Principles of Microeconomics (Econ 2)
Drake University, Summer 2010
Quiz 5
Page 2 of 7
II. Problems: Insert your answer to each question below in the box provided. Use the graphs and 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.
Price
(1) [Price controls: 12 pts] The following graph shows the market for flash drives. Suppose a price ceiling (or legal
maximum price) of $ 4 is imposed on this market. No flash drives may be sold for more than $ 4.
$15
$14
$13
$12
$11
$10
$9
$8
$7
$6
$5
$4
$3
$2
$1
$0
Demand
Supply
0
1
2
3
4
5
6
7
8
9
10
11
12
Millions
a. Is this price ceiling binding or nonbinding?
b. Find the quantity of flash drives actually sold with this price ceiling.
million
c. Will this price ceiling result in excess demand or excess supply of flash
drives?
d. How much?
million
e. Are buyers better off as a result of this price ceiling? Answer "ALL,"
"SOME," or "NONE."
f. Are sellers better off as a result of this price ceiling? Answer "ALL,"
"SOME," or "NONE."
Principles of Microeconomics (Econ 2)
Drake University, Summer 2010
Quiz 5
Page 3 of 7
(2) [Quotas: 14 pts] The market for coal is shown in the graph below. Suppose the government wants to limit the use of
coal. The government has decided to impose a quota of six million tons on buyers. Six million permits to buy one ton of
coal are distributed to consumers of coal.
$800
$750
$700
Price per ton
$650
$600
$550
$500
$450
Demand
Supply
$400
$350
$300
$250
$200
$150
$100
$50
$0
0
1
2
3
4
5
6
7
8
9 10 11 12 13 14 15
Millions of tons
a. What will be the equilibrium price of coal with the quota on consumers?
$
per ton
$
per permit
$
million
First, assume that the quota permits are given away to select consumers for free.
b. Compared to the unregulated market, are coal consumers better off?
Answer "ALL," "SOME," or "NONE."
c. Compared to the unregulated market, are coal producers better off? Answer
"ALL," "SOME," or "NONE."
Alternatively, assume the government sells the quota permits to consumers in an auction.
d. What price will be the equilibrium price of a permit?
e. How much money would the government raise from the auction of permits?
f. Compared to the unregulated market, are coal consumers better off?
Answer "ALL," "SOME," or "NONE."
g. Compared to the unregulated market, are coal producers better off? Answer
"ALL," "SOME," or "NONE."
Principles of Microeconomics (Econ 2)
Drake University, Summer 2010
Quiz 5
Page 4 of 7
(3) [Tax: 8 pts] Suppose seven buyers and seven sellers engage in a market similar to the activity we did
Buyer
Bob
Barb
Ben
Bailey
Brian
Betty
Bert
Value
$14
$13
$12
$11
$ 9
$ 7
$ 2
Seller
Sue
Steve
Sam
Sven
Sarina
Sean
Sally
Cost
$ 2
$ 3
$ 4
$ 5
$ 7
$10
$11
$15
$14
$13
$12
$11
$10
Price
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. (You can use
the graph at right for scratch work.)
$9
$8
$7
$6
$5
$4
$3
$2
$1
$0
0
1
2
3
5
6
7
8
Quantity
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?
4
$
units
Now suppose a tax of $ 4 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. How many units of the good will be sold in this market?
units
d. How much tax revenue will the government collect?
$
Principles of Microeconomics (Econ 2)
Drake University, Summer 2010
Quiz 5
Page 5 of 7
Price
(4) [Tax, Laffer curve: 18 pts] The graph below shows the market for watermelons.
$14
$13
$12
$11
$10
$9
$8
$7
$6
$5
$4
$3
$2
$1
$0
Demand
Supply
0
1
2
3
4
5
6
7
8
9 10 11 12 13 14 15
Quantity (thousands)
Suppose the government imposes a tax of $3 per watermelon, to be paid by sellers.
a. Compute the equilibrium quantity with the tax.
thousand
b. Compute the equilibrium total price paid by buyers (including the tax).
$
c. Compute the equilibrium net price received by sellers (excluding the tax).
$
d. Are buyers better off, worse off, or unaffected by this tax?
e. Are sellers better off, worse off, or unaffected by this tax?
f. Compute the tax revenue received by the government.
Now compute the tax revenue received by the government at alternative tax rates.
g. Compute the tax revenue received by the government when the tax rate is
$ 6 per watermelon.
h. Compute the tax revenue received by the government when the tax rate is
$ 9 per watermelon.
i. Compute the tax revenue received by the government when the tax rate is
$ 12 per watermelon.
$
thousand
$
thousand
$
thousand
$
thousand
Principles of Microeconomics (Econ 2)
Drake University, Summer 2010
Quiz 5
Page 6 of 7
Price
(5) [Subsidies: 12 pts] Suppose the market for energy-saving lightbulbs is described by the curves graphed below.
$15
$14
$13
$12
$11
$10
$9
$8
$7
$6
$5
$4
$3
$2
$1
$0
Demand
Supply
0
1
2
3
4
5
6
7
8
9
10 11 12 13 14
Quantity (millions)
Suppose the government offers a subsidy of $ 3 per lightbulb.
a. Compute the equilibrium quantity of energy-saving lightbulbs that will be
sold with this susbsidy.
b. Compute the equilibrium net price paid by buyers (excluding the subsidy).
c. Compute the equilibrium total price 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?
e. Are buyers better off, worse off, or unaffected by this subsidy?
f. Are sellers better off, worse off, or unaffected by this subsidy?
million
$
$
$
million
Principles of Microeconomics (Econ 2)
Drake University, Summer 2010
Quiz 5
Page 7 of 7
III. Critical thinking: Write a one-paragraph essay answering one question below (your choice). [4 pts]
(1) Frequently the complaint is heard that there is not enough affordable day care for children available. Suppose a price
ceiling (or legal maximum price) were imposed on day care services. Would the amount of day care services provided
increase? Who would win and who would lose from this price ceiling? Justify your answer using a supply-and-demand
diagram.
(2) Suppose the government offered a subsidy for children's clothing. Who would benefit from this program, if anyone?
Who would be hurt, if anyone? Justify your answer using a supply-and-demand diagram.
Please circle the question you are answering. Write your answer below. Full credit requires correct economic reasoning,
legible writing, good grammar including complete sentences, and accurate spelling.
[end of quiz]