Download HOMEWORK 2 SOLUTIONS

ECN 111
PRINCIPLES OF MACROECONOMICS
SOLUTIONS TO CHAPTER 4 PRACTICE PROBLEMS
1.
(a) The $2 difference represents “consumer surplus,” the total net benefit
consumers receive from consuming a good. It is equal to the area under the
market demand curve and above the market price, up to the level of consumption.
(b) The $5 difference represents “producer surplus,” the total net benefit received
by producers from participating in a market. It is equal to the area between the
market price and the market supply curve.
2.
(a) A shortage of a good arises when there is a binding price ceiling (like rent
control in New York City). The shortage results because at the artificially low
price, the quantity consumers demand (QD) is larger than the quantity suppliers
are willing to put on the market (QS).
(b) A surplus of a good arises when there is a binding price floor (like the
minimum wage). The surplus results because at the artificially high price, the
quantity consumers demand (QD) is less than the quantity suppliers are willing to
put on the market (QS).
3.
Economists oppose government controls on prices because the price mechanism
(also called the “invisible hand”) has the crucial job of coordinating all economic
activity by helping to balance demand and supply. When policymakers set
controls on prices, they obscure the signals that guide the allocation of society’s
scarce resources. Furthermore, price controls often hurt those they are trying to
help.
4.
(a) With no price ceiling, the equilibrium price of gasoline would be P* = $3.00
per gallon and the quantity demanded and quantity supplied would both be Q* =
40 million gallons per month.
(b) With the binding price ceiling, the price of gasoline is $2.00 per gallon, the
quantity demanded is 45 million gallons, the quantity supplied is 30 million
gallons, and there is a shortage of 15 million gallons.
(c) Consumer surplus = A + B + C; producer surplus = D; and deadweight loss =
E+F
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(d) They are, at least in the short run, because their consumer surplus with the
price ceiling is A + B + C, but without the ceiling it would be only A + B + E.
(NOTE: C is larger than E. E’s area is [0.5 * 10,000,000 * $2.00 = $10,000,000,
while C = $1.00 * 30,000,000 = $30,000,000.)
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