Download 1) Diamond – Water Paradox: A friend who hasn`t taken an

Professor Scholz
Economics 101, Problem Set #3
Posted: 9-15-09
Due: 9-22-09
1) Diamond – Water Paradox: A friend who hasn’t taken an economics class hears you
are in Econ 101 with Prof. Scholz. One night at a party that friend asks you, “Water is far
more useful than diamonds are. In fact, it is absolutely necessary in order to sustain life,
but diamonds command a much higher price than water does – why is that?” Use your
knowledge of how price is determined (in markets) to answer your friend’s question. Do
so both graphically and in words.
2) The Minnesota Vikings go 0-16 and Brett Favre decides to come back for another season,
prompting many Minnesota fans to give up their season tickets. 25% of former ticket holders say
they won’t attend a game next season. Explain the following:
a) Which graph from above could be used to show this result?
b) What effect will this change have on ticket prices, assuming supply in unchanged?
3) Redraw the graph you chose in Problem 2. Add a supply curve. Now assume that the Vikings
also finish an addition to their stadium in the offseason that (somehow) adds 25,000 seats.
Explain the following:
a) Show, graphically, the effect this will have on supply.
b) What effect will this change have on ticket prices? Are tickets cheaper, more
expensive or the same price as they were prior to the stadium addition?
4) Suppose market demand for widgets (in millions) is given by the equation QD= 12- P,
while widgets are supplied according to the market supply equation QS=2P.
a) Calculate the equilibrium price and quantity, consumer surplus, and producer
surplus. Graph your results.
b) Suppose the government imposes an excise tax on widget producers of $3 per
widget. Graph the changes in the equilibrium price and quantity. (Hint: to see
how the tax will shift the supply curve, solve for the “inverse supply curve” –
price as a function of the quantity supplied. Then add $3 to the right hand side of
the inverse supply curve, implying that price is $3 higher for every quantity of
widgets sold).
c) Show on a graph the new producer surplus and consumer surplus. Also show
the tax revenue and the deadweight loss. How much revenue is the government
getting from the tax?
5) Imagine the graph above represents the market for used textbooks in Math 101. We
assume that only the bookstore sells books and there is no black market. Use it to answer
the following questions:
a) In order to hold down costs to students, the University puts a ceiling on the
price the bookstore can charge for a used book. That ceiling is $25. Is this an
effective policy? Why or why not?
b) Suppose that next year, the University tries to reward those who previously
purchased books by imposing a price floor (support) of $15 on the same
market, is this an effective policy? Why or why not?
6) Using the same graph as question 5, calculate the consumer and producer surplus at
initial equilibrium. Give both the demand and supply functions.
a) Then, imagine a $15 excise take was added to the cost of textbooks in order to
for upgrades to the faculty lounge. What is the new equilibrium price?
b) Calculate the effect on consumer and producer surplus.
c) What, if any, is the deadweight loss caused by the imposition of the tax?
d) What are the government revenues from the tax?
e) Finally, who bears the greater incidence of the tax, the consumer or the
producer?
7) Suppose that market demand for UW baseball caps is given by Q D = -2P + 140 and market
supply of the caps is given by Q S = P – 10.
a) Find the equilibrium price and quantity in this market.
b) Suppose the Wisconsin state government obtains evidence that students who wear UW
baseball caps perform worse on their final exams. The government would like to reduce the
number of caps exchanged in hopes of improving final exam performance.
i) If the government wishes to create a price floor to accomplish its objective, what is the
minimum price it would have to set to make sure no caps are bought by consumers?
ii) Say the government sets a price of $55 for the caps. What is the excess quantity supplied
(surplus) in this case? Give a general expression for the surplus as a function of the price in this
market (hint: this is Q S - Q D ). If at some price the surplus is negative, what do we call that?
c) Suppose now that market demand for UW baseball caps has changed to Q D = -2P + 170. Give
a possible explanation for the change. What do you expect to happen to the equilibrium price
(relative to that of part a)? What do you expect to happen to the equilibrium quantity (relative to
that of part a)? Find the new equilibrium to verify your answers.
8) Sometime in the near future, U.S. consumers complain that at (then) current market
prices for gasoline they cannot afford to drive to work. In response to the public outrage,
the government imposes a price ceiling on gasoline in the U.S. of $3/gallon. Prior to the
imposition of the price restriction, market demand was given by the equation QD = 20-2P
and supply was given by QS = P -1. What effect does this ceiling have on the supply of
gasoline to U.S. consumers? Calculate the deadweight loss and show graphically the
effects on consumer surplus. What problems might be associated with this policy?
(Quantity is in billions of gallons)