Download Chapter 5: Markets in Action

Chapter 5: Markets in Action
Question 2
a) With a binding price ceiling, the excess demand means that consumers must somehow
be rationed by means other than price. This situation often encourages rationing by “sellers’
preferences,” including rationing by:
• religious beliefs or affiliation
• race
• sexual preferences
• occupation
b) With a binding price floor, the government could choose to purchase the excess supply,
thus transferring resources from taxpayers to producers. Alternatively, the government
could introduce a quota system so that the producers face an upper limit on production
equal to the quantity demanded at the floor price.
c) If the government views the product in question as a necessity, it may introduce a price
ceiling in the hope that it will improve consumers’ access to the product. However, to the
extent that the quantity supplied will fall, overall access will be reduced by such a policy.
d) If the government views the sellers of the product as deserving of support, a price floor
may be seen as a desirable policy. (This is the motivation for a legislated minimum wage.)
However, to the extent that quantity demanded for the product will fall, some sellers of the
product may see their markets disappear.
Question 4
a) The free-market equilibrium is where quantity demanded equals quantity supplied. From
the table this occurs at a price of $800 per month and a quantity of 70 000 units.
b) Any ceiling on the price of rental apartments must be below the free-market equilibrium
price to have any effect on the market. Thus the highest it can be is just below $800.
c) At a ceiling of $500 per month, quantity demanded is 100 000 units and quantity
supplied is 60 000 units. There is excess demand (a shortage) of 40 000 units. There has
also been a reduction in the equilibrium quantity exchanged (from 70 000 to 60 000 units).
d) At a quantity of 60 000 units, the maximum price that consumers are willing to pay is
$900 per month for rental accommodation. If all units were supplied on the black market,
$900 would be the black-market price.
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Question 6
a) For the supply curve: QS= 20 + 8p, the diagram is as follows:
b) As the world price of oil rises, two things are happening. First, more oil is being
extracted from existing oil wells. Second, new oil wells are being explored and drilled.
c) At a high price of $16 per barrel, Canadian supply equals 148 million barrels per month.
The monthly income of producers is therefore $2.368 billion. At a low price of $9 per
barrel, Canadian supply is 92 million barrels per month. Monthly income is therefore $828
million. On the diagram this is shown as the movement between points A and B on the
Canadian supply curve.
Question 8
This question requires the student to solve a system of demand and supply curves as is
done in the box near the end of Chapter 3.
a) The free-market outcome is determined where quantity demanded equals quantity
supplied, QD = QS. Setting p from the demand curve equal to p from the supply curve, we
get
225 – 15Q = 25 + 35Q
⇒ 200 = 50Q
⇒ Q* = 4
Putting Q*=4 back into the demand curve we get
p* = 225 – (15 × 4)
⇒ p* = 165
Thus the free-market price of milk is $1.65 per litre and the equilibrium quantity is 4
million litres per month.
b) At the guaranteed price of $2.00 per litre, quantity demanded is given by
200 = 225 – (15 × QD) ⇒ QD = 1.67 (1.67 million litres)
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At the same price, quantity supplied is given by
200 = 25 + 35QS
⇒ QS = 5
(5 million litres)
c) Since the government has guaranteed to purchase any amount that the producers cannot
sell, the producers will produce the full 5 million litres per month. Thus, at the guaranteed
price of $2.00 per litre, there is excess supply of 3.33 million litres per month. This amount
will be purchased by the government at a cost (to taxpayers) of $6.66 million per month.
d) The government purchase of milk is financed by taxpayers. Taxpayers are clearly
harmed since they must foot the direct bill for this system of price supports. Consumers are
also harmed since they consume less milk and must pay a higher price than would be
available in the free market. Milk producers are clearly better off. Not only do they get a
higher price per litre, but their surplus production is all purchased by the government.
Question 10
This is a good question to reinforce the idea of market linkages and also to remind the
student of the effects of excise taxes (from Chapter 4).
a) The demand and supply curves look as follows. For simplicity, we assume that in the
initial situation the price of cigarettes is the same in both markets.
b) Following the arguments in the final section of Chapter 4, the reduction in cigarette
taxes in the Eastern market leads to a rightward (or downward) shift in the supply curve
from S to S′. The immediate effect is to reduce the equilibrium price to p1 and raise
equilibrium quantity. This is the move from E0 to E1 in the right-hand diagram.
c) Sellers in the Eastern market now notice that cigarettes are more expensive in the
Western market because taxes there have not fallen. There is an incentive to smuggle
cigarettes from the East to the West, selling them at the higher Western price. This is
illegal in Canada (though it happened in the event described in 1994). The effects of
large-scale smuggling would be to shift the supply curve in the East to the left and shift
© 2005 Pearson Education Canada Inc.
the supply curve in the West to the right. This is the movement to E2 in both diagrams,
where the prices of cigarettes are again equalized across the two markets.
d) There are two limits on the extent of smuggling. First, it is illegal. The illegality of
smuggling means that smugglers face some probability of being caught and punished.
The second limit is the direct cost of smuggling, including transactions and transportation
costs. Both aspects of smuggling mean that the price will not be exactly equalized across
the two markets. However, if there were no such limits on smuggling, then we would
expect the price to be exactly equalized.
© 2005 Pearson Education Canada Inc.