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Markets Problem #4 Answers (
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Open the Markets module. For each of the following scenarios, compare your
results with the default values. Each scenario contains only one change that you will
report results on. You may attach printouts of the tabular and/or graphical results
of each change so long as they are carefully integrated into your answer.
1.
Disturb the market by changing the amount of rainfall while keeping the
other variables at their default values. Compare the results before and after
this change in supply. How does the amount of rainfall affect supply?
Explain this relationship. Thoroughly discuss the impacts on consumers and
producers as a result of this change. Calculate the price elasticity of demand.
Suppose rainfall was increased from 10 to 20 inches. Assuming that this increase was not
so big it damaged the crop, this change would increase the production of wheat given the
same inputs or other resources. Because the sellers have more wheat to sell, the supply
curve would shift to the right, an increase in supply. This would create a surplus of
wheat. Sellers would bid the price down to the new equilibrium price and quantity. At
the new equilibrium, the price will be lower and the quantity will be higher. Consumers
benefit because they get more wheat for less money. Sellers must unload their goods at
low prices and get smaller revenues for the larger crop. See the graph below:
Price of Wheat
S
S′
P
P′
D
Q
Q′
Quantity of Wheat
Since there is a movement along the demand curve, we can calculate the price elasticity
of wheat. With a downward sloping demand curve, the price elasticity of wheat is always
negative.
EP = (986.25 – 869.59)/(.5*(986.25 + 869.59))/($11.73 - $23.39)/(.5*($11.73 + $23.39))
= 0.1257220/-0.6640091 = - 0.1893378
Since the price elasticity of demand is less than one in absolute value, the demand for
wheat is said to be price inelastic.
2.
Now disturb the market by changing the number of farms while keeping the
other variables at their default values. Compare the results before and after
this change in supply. How does the number of farms affect supply? Explain
this relationship. Thoroughly discuss the impacts on consumers and
producers as a result of this change. Calculate the price elasticity of demand.
If your result is not exactly the same as in (1) explain why.
Suppose that the number of farms was reduced from 1,000 to 600. This might be due to a
disaster ( such as the Dust Bowl of the 1930s in the U.S.) that destroyed huge parcels of
land across the nation. Ceteris paribus, (disregarding the effects of such a change on
other variables), this would cause supply to decrease, shifting the supply curve up and to
the left. With fewer sellers, there will be less wheat sold on the market.
This will create a shortage where there will be more buyers than sellers at the original
equilibrium price. The buyers will bid the price up to its new equilibrium point. The
new equilibrium point will be at a higher price and a lower quantity. Consumers will be
hurt because they will get less wheat for a higher price. Sellers will face less competition
and, while there will be less wheat to sell, their revenues will increase. See the graph
below:
S′
Price of Wheat
S
P′
P
D
Q′
Q
Quantity of Wheat
With a downward sloping demand curve, the price elasticity of wheat is always negative.
The calculation of price elasticity is below:
EP = (782.63 – 869.59)/(.5*(782.63 + 869.59))/($32.09 - $23.39)/(.5*($32.09 + $23.39))
= - 0.1052644/0.3136265 = - 0.3356361
This is not the same as the previous answer because we are at a different point along the
demand curve. With a straight-line demand curve, the elasticity will vary along different
points on the curve.
3.
Next return the variables to their default values and regulate the market.
Impose an effective price floor. What range of prices is available for an
effective price floor? Explain. Explain the impacts on producers and
consumers as a result of the price floor. Draw a graph of the situation and
label all relationships, axes and significant points on the graph. Provide a
real world example of a price floor.
Any minimum legal price above the current equilibrium price of $23.39 will create a
price floor. If the legal minimum price was below or equal to the current equilibrium,
then the market would just gravitate to the equilibrium and there would be no effect. A
good example of a price floor is minimum wage legislation in the United States. The
surplus labor creates unemployment. An effective price floor will create a surplus of
sellers who want to sell at the higher price.
There will be a surplus of wheat at the floor price. Since the point is to keep the price
from being bid down to its equilibrium, the government purchase and store the excess
quantity of wheat. Sellers will benefit from the higher quantity sold at the higher price.
However, consumers will be paying more for their wheat and must also pay higher taxes
to support the governmental purchases and storage of wheat. See the graph below:
Price of Wheat
S
Price Floor
D
QD
4.
QS
Quantity of Wheat
Now leave all the demand and supply variables at their default values and
impose a quantity control. Enter any quantity below the current quantity.
Why would the government want to reduce the production of wheat?
Explain. Discuss the impact of this regulation on farmers’ incomes, the price
and quantity of wheat as well as the percentage of the farm and non-farm
vote. Which voter segment would support this regulation and which segment
would oppose it? Why?
Quantity controls below the equilibrium quantity have existed in the United States for
many years as a result of special interest lobbying on the part of farmers’ associations
(e.g., tobacco). If the government requires a lower quantity of wheat to be produced, a
shortage of wheat will result. Consumers who want to buy the limited supply of wheat
will bid up the price of wheat. Farmers obtain a higher price of wheat, which is
somewhat similar to what a monopolist does in the theory of pure monopoly. Because
demand for many farm products is inelastic farmers’ incomes are increased tremendously
by these programs. In the SimEcon® module, I restricted the quantity of wheat to 800
units. As a result, farmers’ incomes rose from $20,339.71 to $24,280.00.
In the United States, two senators from a sparsely populated state such as Idaho or South
Dakota have as much voting power as two senators from California, even though
California has the fifth largest economy in the world. (California is a very large
agricultural producer, but that industry is less important in California relative to other
interests than is the case in those less urban and industrial states.) This situation has
created a very powerful farm lobby in the United States. They advocate quantity controls
to serve their special interest groups, farmers’ associations. These programs have no
other benefit and are in fact detrimental to general societal welfare. In the SimEcon®
program, the percentage of the farm vote rose, while the percentage of the non-farm vote
fell. This change reflects the competing interests of farmers versus wheat consumers.