Download VIP 06. New Problem Supply and Demand for Wheat

VIP HW 5, Fall 2014 ©Prof. Dohan
Name:
Course Number: 101, 102 Student ID #: ________________
Supply and demand problem for wheat (32 points)
The Basics: The demand and supply for wheat (ceteris paribus) in a very poor country is represented by the
following demand function and supply function looking at only one independent variable price denoted by P for
each side of the market.
Qd = 560 -10P where Qd is the Quantity demanded or the willingness to buy that much wheat at each price P.
Qs = -400+20P where Qs is the Quantity supplied or the willingness to sell that much wheat at each price P.
For the wheat market to be in equilibrium, there has to be a “market clearing” or “equilibrium price”, denoted by P*, at
which the quantity demanded by the buyers at that price must equal the quantity supplied by the sellers at that price. Or to
state it another way, there is a willingness to buy just that amount of wheat at the market clearing price as there is a
willingness to sell just that amount of wheat at the market clearing price. Mathematically, it can be represented as,
Qd(P*) = Qs(P*) where P* = the market clearing price. SO WE HAVE THREE EQUATIONS AND THREE UNKNOWNS.
a) Find the equilibrium price or market clearing price(P*) and equilibrium quantity (Q*) using algebra. Show
work to receive full credit. (8 points)
P*= ________
Q*= ________
b) Graph and label the supply and demand curve. Label the market clearing price and equilibrium. (8 points)
Make your scale on the graph reasonable. The maximum number on the quantity scale x-axis should be 500
(why?) and on the price scale, y-axis 50 (why). Because if P = 0, quantity of wheat demanded will not exceed 500
and the quantity of wheat demanded falls to zero at P = 50. P = 50 is called a choke price, at which quantity
demanded = 0.
Price of wheat
Quantity of wheat
Government’s direct interference with market prices often leads to bad results as shown below.
On occasion, the government tax or subsidy can move the market price to an efficient price, e.g. in
case of externalities. (Definition of externality given at the end of the homework)
Price support programs are justified for many reasons from national defense and encouraging R & D and
energy independence to providing certain groups of citizens a fair return on their labor (especially in
agriculture) and supporting selected groups of producers for political reasons.
One type of price support, for example, is that the government guarantees the seller that they will get at least
$40/unit of wheat for the crop. Under such program, the government guarantees to buy enough wheat on
the open market whenever the price falls below $40 so that the market price is always at $40. Farmers get
$40/unit for their wheat and buyers pay $40/unit for their wheat. (Even though that is not the market clearing
price)
Qs($40) = _________1) How much do farmers grow for sale at $40/unit? (2 points)
Qd($40) = _________2) How much do buyers want to buy at $40/unit? (2 points)
3) Is there excess supply or excess demand? (circle one) (1 point)
4) Illustrate the price support policy on the graph. (2 points)
5) What problems will the government face in running such a program? (1 point) ___________________
In poor countries, the government often sets a price ceiling at $25. Price ceiling is a maximum
price that the seller can charge for a commodity.
Qs($25) = ___________1) How much do farmers grow for sale at $25/unit? (2 points)
Qd($25) = ___________2) How much do buyer want to buy at $25/unit? (2 points)
3) Is there excess supply or excess demand? (circle one) (1 point)
4) Illustrate the price ceiling policy on the graph. (2 points)
5) What problem will the government face in enforcing this price ceiling so that no seller sells at a price
higher than the price ceiling? (1 point) ________________________________
Externality: is an external cost to society which is not paid for by the industry or person consuming the good or
service. for example: air pollution from using coal in electric power generation, or health effects of the
second hand smoke from people smoking cigarettes. In this case, the market price is too low that is it’s below
the social cost.
External benefits: benefits that accrue to other people or firms from the work or activities of firms or people.
Such as, the pleasure that people get from looking at a beautiful garden planted by a homeowner or from
improvements in safety when a car manufacturer installs more safety belts.
Ceteris Paribus: holding all other variables constant.