Download Chapter 5: Q7, Q8 and Q9

Chapter 5: Q7, Q8 and Q9.
Question 7
a) The bumper crop of European barley is shown in the world barley market as a
straightforward rightward shift in the supply curve. The world price falls and the
equilibrium quantity rises (though probably not by much since world demand for barley is
likely to be quite inelastic).
b) For Canadian barley growers, the price they face is determined in the world market; they
are price takers. The appropriate diagram for the Canadian barley growers shows their
upward-sloping supply curve and the given world price. As the world price falls from p1 to
p2, the quantity supplied by Canadian barley growers falls from Q1 to Q2. Their collective
income therefore falls by the amount of the shaded area.
c) This is just the same logic working in reverse. When other parts of the world experience
a crop failure, the world supply curve for the crop shifts to the left and the world price rises.
In this case, Canadian farmers (with no crop failure) increase their quantity supplied of the
crop and benefit from an increase in income.
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)
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 9
This question relates to the previous question on milk production. The government issues
quota for 1.67 million litres per month rather than using a direct price support.
a) If milk producers produce the maximum allowed by the quotas, then production will be
1.67 million litres per month. Given the demand curve (p = 225 – 15QD), this implies a
price of
p = 225 – (151.67)
 p = 200 cents (or $2.00) per litre.
b) In the previous question with direct price supports, the price was $2.00 per litre and
consumers purchased 1.67 million litres per month. That is also the case when this quota
system is used. Thus, consumers do not detect a difference between the direct price
supports and the quota system. Taxpayers surely prefer the quota system since the
government is not obliged to purchase the surplus production that would otherwise occur
under the system of direct price supports. Finally, milk producers are clearly worse off
under the quota system than under the direct price supports. With the quota system, they
produce 1.67 million litres per month and sell each litre at a price of $2.00. But with the
direct price supports they produce 5 million litres per month and sell each litre at the same
price. Their collective income is therefore higher by $6.66 million per month under the
system of direct price controls.