Download Markets Exercise #5 Answers

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Markets Exercise #5 Answers (
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Please limit your answers to the spaces provided. If necessary, write on the back of the page. Do not
attach printout or additional pages. All questions pertain to the Markets module in the SimEcon®
software package.
Make sure that you have read the “Markets Manual” and “SimEcon® Operation Instructions.”
These materials may be found at the Class Web site prior to beginning the exercise. For many of the
exercise’s questions, it will be necessary to refer to those instructions. For many of the exercise’s
questions, it will be necessary to refer to your text.
Part 1: Making Sure that People Have Enough to Eat
Suppose that the government was interested in making sure that the people of the nation had enough
food to eat. Thus, the government would be interested in increasing food production. To do this, the
government could disturb the market by developing new technology that would increase the
productivity of wheat farms. Another thing that the government could do would be to regulate the
market.
To begin, write down the initial equilibrium price and quantity in the wheat market: equilibrium
price = $23.39 and equilibrium quantity = 869.59. If the government wanted to make sure that its
people had enough to eat, the government should be most interested in changing the supply
(demand, supply) of wheat. Why?
If the supply of wheat is increased there will be a lower price, so the poor are more likely to be
able to afford it, as well as there being more wheat in the physical sense.
Now select “Regulate Market” and “Control Quantity.” Given the stated goal, what quantity
regulation would be more appropriate, a quantity of 700 or a quantity of 1000? 1000. Why? More
production means a lower price and is better for the poor.
Continue with the quantity regulation, and choose a quantity of 1000. What was the income of
farmers before the regulation? $20,339.71. After the regulation? $10,350. What is the percentage
of the farm vote? 33.77%. What is the percentage of the non-farm vote? 54.60%. If the
government pursued this policy, do you think that it would win the next election? (Yes, No) Yes. If
so, why would it succeed or fail? The farm vote is only 3% of the population so before the total
vote percentage would be (50.3 * .03) + (51.77 * .97) = 51.73 and with this regulation it will be
(33.77 * .03) + (54.60*.97) = 54.50. The administration has more support with this policy than
without it.
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Markets Exercise #5 Answers
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Regarding the decision to control production in this matter, do you think that it agrees with economic
theory or political expediency? Political expediency. Why? Economic analysis would require
consideration of the long term effects of this type of regulation. This regulation forces farmers
to sell their products for less than it costs to produce them. Eventually there will be a lot
fewer farmers and it will not be possible to maintain this level of production.
Do you think that this type of regulation would be more characteristic of an industrialized nation or
a developing country? Developing nation. Why? Developing nations have more poor, starving
people who would benefit from such a program. They also have governments even more
prone than those in rich countries to disregard long term ill-effects of policies.
Part II: Making Sure that Farmers Stay in Business
Before continuing with this section of the assignment, select “New Regulation.” Suppose that in this
case, the government was more interested in making sure that farmers had enough income rather than
feeding the people. If this was the goal, and the government wanted to do this by regulating the
price, would it set a price of $22 or $26? $26. Why? If the government set a minimum price of
$22, the economy would automatically adjust to the equilibrium price of $23.39. There would
ultimately be no change in price.
If the government selects a price of $26, would it want a price ceiling or a price floor? Price floor.
Why? To increase farmers’ incomes, we would want to raise the price above the equilibrium
price of $23.39. This would require a minimum price, which is a price floor.
Select a price of $26 and continue. What is the quantity supplied with this regulation? 1,000.
What is the quantity demanded with this regulation? 843.50. Do we have a surplus or a shortage in
this situation? Surplus. Why? Because quantity supplied is greater than quantity demanded
at the minimum price.
What were farmers’ incomes before the regulation? $20,339.71. What are farmers’ incomes after
the regulation? $26,000.
What are the total government expenditures with this regulation? $4,108.13. If you were a farmer,
would you support this program? (Yes, No) Yes. Why would you, as a farmer, support or oppose
this program? The price floor raises the price of my products, which increases my income.
If you were not a farmer, would you support this regulation? (Yes, No) No. Why or why not? As
a consumer, I would pay higher prices for the bread and wheat that I buy. I also would be
paying the taxes that provide the funds that buy up and store the surplus.
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Do you think that the above program is characteristic of United States’ farm policy? (Yes, No) Yes.
Do you personally support this policy? (Yes, No) No. Why or why not? Even though it is often
described as a way to help the “small family farmers it is one giant welfare program for big
corporate farms. It helps big farmers more than small ones because the more you produce the
more you gain from the higher price.
Suppose instead that the government wanted to make sure that farmers had enough income by
controlling the quantity produced. Given the original equilibrium price and quantity, would it select
an imposed quantity of 890 or 850? 850. Why? Lower production means a higher price and
since demand is inelastic that means more revenue at the higher price.
Select a required quantity of 850. What were farmers’ incomes before the regulation? $20,339.71.
What are farmers’ incomes after the regulation? $21,547.56. Are there any government
expenditures required to support this program? (Yes, No) No. With this regulation, what is the
percentage of the farm vote? 51.78%. What is the percentage of the non-farm vote? 51.04%.
Do you think that, with this program, the government would win reelection? (Yes, No) Yes. Why
or why not? I have a majority of both voter segments.
In order to make sure that farmers have enough income, do you think it would be better to regulate
price or quantity? Quantity. Why? No storage/disposal costs.
Part III: Analyzing Disturbances to the Market
At this point, select “Menu” to begin the module again. Without any government regulation, if the
nation had an especially rainy season, do you think that this would be beneficial to wheat consumers,
wheat farmers, or both? Consumers would benefit, farmers might benefit. Why? Farmers
would enjoy lower costs and higher productivity but because demand is inelastic their
revenues drop. In principle it depends on which is larger the drop in costs or the drop in
revenues. In the real world they would probably lose. Consumers would pay lower prices and
get more of the product (the amount of consumer surplus increases).
Increase the rainfall to 15 inches and see what happens. What is the new equilibrium price? $17.56.
What is the new equilibrium quantity? 927.92. Do you notice a change in supply or a change in
quantity supplied? Supply. Why? The beneficial rainfall shifts the supply curve to the right.
Do you notice a change in demand or a change in quantity demanded? Quantity demanded. Why?
The demand curve does not shift. We are only moving along the demand curve.
Would an improvement in technology exhibit the same types of economic changes as the changes
shown here? (Yes, No) Yes. Why? An improvement in technology would reduce production costs,
which would increase supply. This would cause a rightward shift of the supply curve.
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At this point, select “Menu,” and start the process over again. Suppose that a revolutionary new
wheat producing technology was suddenly developed. Without restarting the module, what would
happen to farmers’ economic profits in the short run? (increase, decrease, remain the same)
Increase. Why? An improvement in technology will reduce production costs in the same
manner as before.
If farmers are earning above normal profits would more people be encouraged to enter the wheat
farming business (Yes, No)? Yes. Why or why not? Everyone wants to earn above normal
profits. Wheat farming would thus be a more attractive investment that other types of
businesses.
Now select a new market disturbance by increasing the number of farms to 1,500. What is the new
equilibrium price with this change? $18.28. What is the new equilibrium quantity with this
change? 920.74. Do you think that consumers will benefit from this change (Yes, No)? Yes. Why
or why not? Consumers will enjoy a larger quantity of wheat at a lower price.
Will producers benefit from this change? (Yes, No) No. Why? The increased competition (with
more producers) drives down the price and if there were any positive economic profits before
it will reduce or eliminate them. If the change is large enough it might even create economic
losses for the farmers.
Has the increase in the number of farms caused a change in supply or a change in quantity supplied?
Supply. Why? There has been a rightward shift of the entire supply curve.
Has the increase in the number of firms caused a change in demand or a change in quantity
demanded? Quantity demanded. Why? The demand curve has not shifted. There has only
been a movement along the demand curve.
Part IV: Making Sure that People Can Afford to Buy Bread
Restart the module by selecting “Menu.” Suppose that the government’s objective was to make sure
that people had enough food to eat by keeping the price of wheat so low that people could afford to
buy it themselves. In this case, would you be regulating the price or the quantity? Price. If you
decided to regulate the price, would this be called a price ceiling or a price floor? Ceiling. Why?
You would want to set a minimum price below the equilibrium price.
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Select a maximum price of $20 and see what happens. What is the quantity supplied at the legal
price? 700. What is the quantity demanded at the legal price? 904.25 (Hint: Consult the
Markets Manual to help you with this question). Do we have a shortage or a surplus at the legal
price? Shortage. What are your reasons for this answer? The quantity demanded of 904.25 is
greater than the quantity supplied of 700.
What were farmers’ revenues before the regulation? $20,339.71. What are farmers’ revenues after
the regulation? $14,000. If you were a farmer, would you support this regulation (Yes, No)? No.
Why or why not? Farmers will make less money with the program than without it, so they
would oppose it.
Now, select the icon for “Hire Cops.” Select three different amounts for law enforcement
expenditure: $2,500, $5,000 and $7,500. Fill in the table below:
$2,500
Criminals’ Profits With Enforce: $15,319.85
Criminals’ Profits W/O Enforce: $14,245.00
Illegal Price With Enforce:
$40.35
Illegal Price W/O Enforce:
$42.58
Tot. Spend Non-Criminal Public: $29,319.85
$5,000
$7,500
$17,829.11
$14,245.00
$49.05
$40.35
$31,829.11
$20,151.88
$14,245.00
$59.83
$40.35
$34,151.88
How much would you spend for law enforcement in this situation? $2,500. Why? This amount
results in the lowest total spent by the non-criminal public.
Are there any criteria other than the information in the table above that should be considered in
determining how much you spend? Yes. Explain. The amount listed in the table includes only
what consumers pay for wheat. The amount being paid to cops was not included. Society
might want to consider the level of criminals’ profits and the illegal price with enforcement
compared to the illegal price without enforcement. These factors might indicate how well the
society is addressing the problem. Society might want to spend more money for socially
desirable results; there might be intrinsic reasons outside of economics for reducing activity in
this illegal market.
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