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Economics 210
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Exercises for Gwartney, Stroup, Sobel, and Macpherson, Chapter 4, “Supply and
Demand: Applications and Extensions”
Open the workbook GSSM4_ApplicationsExtensions.xls.The bold names before the
descriptive material below is the name of the sheet to which you are to refer when
answering a question.
Equilibrium. (Corresponds to Chapter 3, Exhibit 10.)This spreadsheet shows how the
demand and supply curves determine the equilibrium price and quantity. If the price is
above the equilibrium price, the quantity that sellers are willing and able to provide
exceeds the quantity that buyers are willing and able to purchase. The resulting surplus
will put downward pressure on the price, pushing it back toward the equilibrium.
Likewise, if the price falls below the equilibrium price, the quantity demanded exceeds
the quantity supplied. The resulting shortage pushes the price back toward the
equilibrium price. This sheet provides the point of departure for the remainder of the
sheets in the workbook.
No question for this sheet.
Disequilibrium. (Corresponds to Chapter 3, Exhibit 10.) This spreadsheet shows
quantity demanded and quantity supplied at prices other than the equilibrium price.
Demand and Supply are the same as in the previous workbook, but the price is not the
one that results in equality of the quantity demanded and the quantity supplied.
1. a. Choose a price below the equilibrium price. If the price is $_____, then the
quantity demanded is ______ units while the quantity supplied is _______ units.
Thus, this price results in a shortage of _______units.
b. Choose a price above the equilibrium price. If the price is $_____, then the
quantity demanded is ______ units while the quantity supplied is _______ units.
Thus, this price results in a surplus of _______units.
Product_and_LaborMarkets. (Corresponds to Chapter 4, Exhibit 1.) A change in the
labor market that results in a changed wage rate affects the supply of goods that employ
the type of labor in question. This sheet, which corresponds to Exhibit 1, illustrates this
relationship.
2. a. Shift the labor supply curve to the left. The equilibrium wage rate becomes
$________. This change causes the supply of apples to shift to the ________
(left/right) and the price to change to $________.
b. Shift the labor supply curve to the right. The equilibrium wage rate becomes
$________. This change causes the supply of apples to shift to the ________
(left/right) and the price to change to $________.
Product_and_LaborMarkets2. (Corresponds to Chapter 4, Exhibit 1.) A change in the
product market that results in a changed product price affects the demand for resources
that are employed in producing the product. This sheet, which corresponds to Exhibit 1,
illustrates this relationship.
2. a. Shift the apple demand curve to the left. The equilibrium price becomes
$________. This change causes the demand for apple pickers to shift to the
________ (left/right) and the wage to change to $________.
b. Shift the apple demand curve to the right. The equilibrium price becomes
$________. This change causes the demand for apple pickers to shift to the
________ (left/right) and the wage to change to $________.
LoanableFunds. (Corresponds to Chapter 4, Exhibit 2.) The interest rate affects the
supply of loanable funds by changing people’s incentives to save part of their income
rather than consuming it in the present period. The interest rate affects the demand for
loanable funds by changing the cost of undertaking investment projects for which the
funds are being borrowed. The interest rate tends to reach the level at which the supply of
loanable funds (from saving) equals the demand for loanable funds (to finance investment
projects).
3. Initially, the demand and supply are such that the quantity demanded of loanable
funds is $30 billion per year, with an equilibrium interest rate of 3 percent per year.
a. Shift the supply curve to the right. This might reflect increased concern over the
future (perhaps concern over Social Security). A rightward shift represents a(n)
___________ (increase/decrease) in the supply of loanable funds. At the new
equilibrium, the quantity of loanable funds is $__________ billion per year, and
the interest rate is _________ percent per year. The change in supply causes a
___________ (shift in/movement along) the demand curve.
b. Return the supply curve to its initial position. Shift the demand curve to the right.
This might reflect increased optimism about prospects for sales in the future. A
rightward shift represents a(n) ___________ (increase/decrease) in the demand
for loanable funds. At the new equilibrium, the quantity of loanable funds is
$__________ billion per year, and the interest rate is _________ percent per year.
The change in demand causes a ___________ (shift in/movement along) the
supply curve.
ForeignExchange. (Corresponds to Chapter 4, Exhibit 3.) The exchange rate affects the
supply of foreign exchange by changing the relative prices of US and foreign goods.
More dollars per Euro (a higher exchange rate) makes US goods more attractive to
Europeans who, accordingly, purchase more and supply more Euros to the foreign
exchange market. The exchange rate affects the demand for foreign exchange in much the
same way. An increased exchange rate makes European goods more expensive to
Americans, reducing the quantity demanded of the Euros required to pay for European
goods. The exchange rate tends to reach the level at which the supply of foreign exchange
(from exports, and from funds supplied by Europeans wishing to invest in the US) equals
the demand for foreign exchange (to finance imports and investments by US citizens in
foreign countries).
4. Initially, the demand and supply are such that the quantity demanded of foreign
exchange is $50 billion per year, with an equilibrium interest rate of $2 per Euro.
a. Shift the supply curve to the right. This might reflect higher prices abroad, higher
income abroad, or an increased desire to invest in the US. A rightward shift
represents a(n) ___________ (increase/decrease) in the supply of foreign
exchange. At the new equilibrium, the quantity of foreign exchange is
__________ Euros per year, and the exchange rate is $_________ per Euro. The
change in supply causes a ___________ (shift in/movement along) the demand
curve.
b. Return the supply curve to its initial position. Shift the demand curve to the right.
This might reflect higher prices in the US, higher income in the US, or an
increased desire by Americans to invest abroad. A rightward shift represents a(n)
___________ (increase/decrease) in the demand for foreign exchange. At the new
equilibrium, the quantity of foreign exchange is __________ billion Euros per
year, and the exchange rate is $_________ per Euro. The change in demand
causes a ___________ (shift in/movement along) the supply curve.
PriceCeiling. (Corresponds to Chapter 4, Exhibit 4.) A price ceiling establishes the
highest allowable price under the law. An example is rent control. If the ceiling is
established below the market equilibrium price, the result will be a shortage in the
market.
5. In this market the equilibrium price is $150 per unit. At that price, 30 units is the
equilibrium quantity.
a. Suppose that the government sets a ceiling price above $150. Why is such a legal
imposition irrelevant (non-binding)?
b. Set a ceiling price below $150. When the ceiling price is $________, the quantity
demanded is ________ units, the quantity supplied is _______ units, and the
___________ (surplus/shortage) is _________ units per time period.
PriceFloor. (Corresponds to Chapter 4, Exhibit 5.) A price floor establishes the lowest
allowable price under the law. An example is minimum wage legislation. If the floor is
established above the market equilibrium price, the result will be a surplus in the market.
6. In this market the equilibrium price is $150 per unit. At that price, 30 units is the
equilibrium quantity.
a. Suppose that the government sets a floor price below $150. Why is such a legal
imposition irrelevant (non-binding)?
b. Set a floor price above $150. When the floor price is $________, the quantity
demanded is ________ units, the quantity supplied is _______ units, and the
___________ (surplus/shortage) is _________ units per time period.
ExciseTaxSupply. (Corresponds to Chapter 4, Exhibit 7.) Placing a tax on the suppliers
adds to the cost of production. Therefore, the amount that must be paid to bring any
specific quantity to the market increases by the amount of the tax. The market price, tax
included, increases. The amount by which the price increases is determined by the shapes
of the demand and supply curves.
7. Select a tax rate. The tax of $_______ causes the supply curve to shift vertically
___________ (upward/downward) by the amount of the tax. Given the demand and
supply curves in this sheet, the price that consumers pay for the good ________
(rises/falls) to $_______ per unit, and the price that producers receive net of the tax
________ (rises/falls) to $__________ per unit.
ExciseTaxDemand. (Corresponds to Chapter 4, Exhibit 8.) Placing a tax on the buyers
reduces the amount that buyers are willing to pay to the sellers of the good. The market
price, tax excluded, decreases. The price including the tax increases. The amount by
which the price changes is determined by the shapes of the demand and supply curves.
8. a. Select the same tax rate that you chose in (7). The tax of $_______ causes the
demand curve to shift vertically ___________ (upward/downward) by the amount
of the tax. Given the demand and supply curves in this sheet, the price that
consumers pay for the good, including the tax, ________ (rises/falls) to $_______
per unit; the price that producers receive, net of the tax, ________ (rises/falls) to
$__________ per unit.
b. Look at ExciseTaxSupply and at ExciseTaxDemand. In both cases, the size of
the deadweight loss is $_________. What does “deadweight loss = $x” mean?
Tax Incidence &Elasticities. (Corresponds to Chapter 4, Exhibit 9.) The effect of a tax
depends on the elasticities of demand and supply. A relatively elastic demand curve
results in buyers paying less of the tax; and a relatively elastic supply curve results in
sellers paying less of the tax. More elastic demand and/or supply curves will tend to make
the deadweight loss larger and the tax revenue smaller, given a per-unit tax rate.
9. a. Set both the demand elasticity and the supply elasticity at 1.0. In this case, the
effect of a tax of $100 per unit is that the price paid by buyers increases to
$_______, the price received by sellers decreases to $________, tax revenue is
$________, and the deadweight loss is $________.
b. Set the supply elasticity at 1.0, and select another value for the demand elasticity.
The demand curve is now ______ (more/less) elastic. Now the effect of a tax of
$100 per unit is that the price paid by buyers is $_______, the price received by
sellers is $________, tax revenue is $________, and the deadweight loss is
$________.
c. Set the demand elasticity at 1.0, and select another value for the supply elasticity.
The supply curve is now ______ (more/less) elastic. Now the effect of a tax of
$100 per unit is that the price paid by buyers is $_______, the price received by
sellers is $________, tax revenue is $________, and the deadweight loss is
$________.
d. Set both the demand elasticity and the supply elasticity at 1.6. In this case, the
effect of a tax of $100 per unit is that the price paid by buyers increases to
$_______, the price received by sellers decreases to $________, tax revenue is
$________, and the deadweight loss is $________.
LafferCurve_GoodsTax. (Corresponds to Chapter 4, Exhibit 11.) A very low per-unit
tax on a good raises little revenue for the government even though the tax base (the
number of units taxed) is large. A very high tax raises very little revenue because the base
becomes small. The Laffer Curve relates each possible tax rate to the amount of revenue
generated. This sheet also shows the deadweight loss associated with each tax rate.
10. a. Set both the demand elasticity and the supply elasticity to 1.0. The tax rate that
raises the most revenue is $______ per unit, where the tax revenue is $______.
Raising the tax from $120 per unit to $150 per unit causes tax revenue to increase
by $_______ and deadweight loss to increase by $________.
b. Keep the demand elasticity at 1.0 and change the supply elasticity. The new
supply elasticity is _________. Now, with this __________ (more/less) elastic
supply curve, the revenue maximizing tax rate _________ (rises/falls) to
$_______, with an associated deadweight loss of $_______.
c. Reset the supply elasticity to 1.0 and change the demand elasticity. The new
demand elasticity is _________. Now, with this __________ (more/less) elastic
demand curve, the revenue maximizing tax rate _________ (rises/falls) to
$_______, with an associated deadweight loss of $_______.
IncomeTax. This worksheet shows an income tax. The height of the demand curve is the
amount employers are willing and able to pay workers at various wage rates. (For
simplicity, we assume that all income is labor income; most is.) The income tax is not a
per-unit-of-labor tax but a per-unit-of-income tax. The tax is treated as proportional to
income. The actual tax formula is more complex, but the analysis changes little if this
complexity is incorporated. “NetWageRate” is “take-home pay”—gross income less
taxes. The higher the wage rate, the greater the difference between gross and net pay.
11. a. When the tax rate is 30%, the amount of labor falls from 1600 to ______ units.
Workers’ take-home pay is $______ per unit of labor. The tax raises revenue of
$_______ and creates a deadweight loss of $_______.
b. Raise the tax to a higher level. A tax rate of _______% causes the tax revenue to
change to $_______ and the deadweight loss to increase to $_________.
c. Of the tax rates you can choose with the scroll bar, a tax rate of _______% raises
the most revenue, $__________. The deadweight loss at this tax rate is $________.
LafferCurve_IncomeTax. (Corresponds to Chapter 4, Exhibit 11.) This worksheet
considers a range of possible demand and supply elasticities and shows the Laffer
Curve for each. If the labor supply curve is inelastic, then the Laffer Curve does not
turn down for realistic values of the tax rate.
12. a. Set both elasticities at 1.0. At what tax rate is tax revenue maximized?
b. Many analysts think the supply of labor is relatively inelastic. Set the supply
elasticity at 0.5 while leaving the demand elasticity at 1.0. Then the Laffer Curve
________ (turns down at a fairly low tax rate/does not turn down until the rate
gets very near 100%).
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