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University of British Columbia
Department of Economics
Econ 101: Principles of Microeconomics
Practice Problems # 3 (Chapters 7 - 9)
1. Market research has revealed that demand for labor in Vancouver is
given by W = 200 – 5L and the supply is given by W = 5 + L, where W
= wage rate and L = Labor hour.
a. Calculate the equilibrium W and L of this market.
b. The government thinks that the equilibrium wage is too low and
wants to protect the workers by setting minimum wage at $50/hr.
What is the effect of this government policy?
c. Will the workers (as a whole) lose or gain from this policy? What
could be the reason behind your result?
Solution
a) At equilibrium, 200 – 5L = 5 + L
or, L* = 65/2 and
W* = 75/2
$
200
S
Wm in = 50
W* =75/2
35
unemployment
D
5
Ld=30
L* =65/2
Ls =45
1
40
Labor
(b) Since Wmin > W*, it is binding and so will affect the labor market. With
Wmin = $50, Ld = 30 and Ls = 45 (note these values can be found by plugging w =
50 into demand and supply equations). Thus unemployment = Ls - Ld = 15.
(c) Before minimum wage law:
Employer’s surplus ES = 1/2 (200-75/2)(65/2) =2640.6
Workers’ surplus WS =1/2(75/2-5)(65/2) =528.1
After the Minimum wage law:
ES =1/2(200-50)30 =2250
WS = (50-35)30+1/2(35-5)30 = 900
Loss in ES = 390.6
Gain in WS = 371.8.
With a binding minimum wage law, employers’ will always lose. However,
workers may lose or gain. While some workers who can keep their jobs
will enjoy higher wage, some others may lose their jobs. In the present
case, the loss to those who lose jobs is less than gains to those who enjoy
higher wage.
2. Suppose a technological advance reduces the cost of making computers.
a. Use supply and demand diagram to show what happens to price,
quantity, and producer surplus and consumer surplus in the market
for computers.
b. Computers and software are complements. What happens in the
market for software due to the technological advance in computer
production technology?
Solution
(a) As a result of technological advance in computer technology, supply
curve shifts to the right and as a result Price falls and Q increases. This will
lead to an increase in PS from area bcf to area deo. Similarly, CS also
increases from abc to ade.
2
$ a
S
S'
c
P1 b
d
P2
e
D
f
o
Q1
Q2
Computer
(b) The decrease in price of computer (due to technological advance) will shift
the demand curve for software to the right as they are complements. As a
result, both price and quantity increase.
$
S
PS'
Ps
D' (lower P of computer)
D (higher P of computer)
Qs
Qs'
Software
3. Suppose that a market is described by the following supply and demand
equations.
QS = 2P
3
QD = 300 – P
a. Solve for the equilibrium P and Q.
b. Suppose that a tax of T is placed on buyers, so the new demand
equation is
QD = 300 – (P+T)
Solve for the new equilibrium Prices (both Ps) and Q.
c. If T = 100, find the deadweight loss caused by this tax.
(for your practice)
4. To conserve the use of heating oil, Canadian government imposes a tax
on it.
a. Would the deadweight loss from this tax likely be greater in the
first year after it is imposed or in the fifth year?
b. Would the revenue collected from this tax likely be greater in the
first year or fifth year?
Solution
$
S' (after tax)
S
P1
DWL1
P5
P0
DWL5
D (fifth year)
D (first year)
Q5
Oil
Q1 Q0
(a)/(b) when tax is imposed on heating oil, its supply curve will shift to the left
(alternatively, you can consider demand shift to the left), price will go up and the
quantity demanded or sold will fall. Demand in the short run (within the period
of time during which consumers cannot adjust their consumption behavior) is
fairly inelastic, so the price rise will be large but the quantity demanded will
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decrease by only a small amount. On the other hand in the long run, people
will respond to higher price of oil by switching to alternative fuels, decreasing
the demand for heating oil. As a result, the deadweight loss will be smaller in
the short run than in the long run. But revenue collected will be higher in the
short run than in the long run; that is R1 = P1Q1 > R5 = P5Q 5.
5. Show graphically
a. How will the burden of tax on land (which is fixed in supply)
sales be distributed between landowners and land buyers.
b. How will the burden of tax on a good with a perfectly elastic
demand be distributed between sellers and consumers.
(for your practice)
6. Imagine that winemakers in BC petitioned the provincial government to
tax wines imported from Ontario. They argued that this tax would both
raise tax revenue and raise employment in BC. Do your agree or
disagree? Support your claims with diagram(s).
Solution
$
S
PBC
PON + t
PON
D
Qs
QS'
Qd'
Qd
BC Wine
BC will import wine from ON only if Wine Price in ON is less than that in BC
(i.e., PON < PBC). When there is no tax on wine imports, imports = Qd - QS.
When tax, t, is imposed on imports, the imports will shrink to Qd’- QS’.
Government Revenue R = t(Qd’- QS’). Similarly, BC production (relative to no
import-tax situation) will also increase from QS to QS’, generating more
5
employment. In this case the losers are BC wine consumers, who will have to
pay higher price (= PON + t).
7. Suppose that a technological advance in Japan lowers the world price of
TVs.
a. If Canada is an importer of TV, how will such drop in price affect
the welfare of Canadian consumers and producers of TV?
b. Suppose now that the Canadian government thinks that this import
will hurt Canadian TV producers and impose a tariff of “t” per TV
imported. How will this affect Canadian producers and
consumers?
(for your practice)
8. When does a country become an exporter or importer of a good? Show
this with the help of diagrams.
(for your practice)
9. Consider a merger in a market in which the supply is perfectly elastic at
a price of 10 dollars. Demand is given by Q = 30 – 0.5 Q
a. Suppose that the evidence shows that the merger is forecast to
raise prices by 15 percent. What will be the dead-weight loss
from the merger?
b. Suppose that additional evidence shows that the pre-merger price
is already 10 percent above the competitive level. Accepting that
the forecast price increase from the merger remains at 15 percent,
what is the deadweight loss associated with the merger?
Solution
D:
Q = 30 – 0.5 P
S:
P = 10.
At equilibrium:
Q = 30 – 0.5 (10) = 25.
and P = $10.
a) If merger causes an increase in 15% of price to $ 11.5, then DWL from
merger = area A + area B + area C
b) If pre-merger price is already at $11.00, then the existing DWL =
area C. Therefore the additional DWL due to merger = area A +
area B.
6
P
60
11.5
A
11
B
C
10
S
25
30
7
Q