ECON 2 - Principles of Microeconomics

ECON 2 - Principles of Microeconomics Signature: Drake University, Fall 2019 William M. Boal

Printed name:

HOMEWORK EXERCISE #7 “Market Controls”

Due Friday, October 11, 2019 Suppose the demand and supply of raw peanuts is given by the following equations. Demand: P = 1.50 – 0.10 Q Supply: P = 0.30 + 0.05 Q where P denotes the price per pound and Q denotes the quantity in millions of pounds.

(1) [Free-market equilibrium: 36 pts]

a. Using a straightedge, plot the demand curve in the graph above. Label it “D”. [Hint: One way to plot the demand curve is to substitute values for Q (0, 1, 2, 3, etc.) into the demand equation and compute the resulting values of P. Then simply plot the combinations of Q and P that you found. They should lie on a straight line, because the demand equation is linear.]

b. Using a straightedge, plot the supply curve in the graph above. Label it “S”. c. Find the equilibrium price. $ per pound d. Find the equilibrium quantity. million pounds e. Compute the total amount of money consumers spend on peanuts (which

equals the total amount of revenue producers receive). $ million

Before answering the next four questions, please review your slideshows from Part 1 on “Willingness-to-Pay and Consumer Surplus” and “Marginal Cost and Producer Surplus.”

$0.00

$0.10

$0.20

$0.30

$0.40

$0.50

$0.60

$0.70

$0.80

$0.90

$1.00

$1.10

$1.20

$1.30

$1.40

$1.50

$1.60

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

P ri ce  p e r  p o u n d

Quantity (millions of pounds)

ECON 2 - Principles of Microeconomics Drake University, Fall 2019

Homework Exercise #7 Page 2 of 2

f. How much was a consumer willing to pay for the eight millionth pound of

peanuts purchased? $ per pound

g. What was the marginal cost of producing the eight millionth pound of peanuts sold?

$ per pound

h. Compute total consumer surplus, the net benefit all consumers receive from this market.

$ million

i. Compute total producer surplus, the net benefit all producers receive from this market.

$ million

Suppose the government wants to help peanut producers by imposing market controls. Consider the alternative policies described in the next two problems. Use your graph on page 1 to answer the following questions. (2) [Price floor: 40 pts] Suppose the government imposes a price floor (or legal minimum price). No peanuts may be sold for less than $ 1.10 per pound.

a. At this controlled price, how many peanuts will consumers want to buy? million pounds b. At this controlled price, how many peanuts will producers want to sell? million pounds c. Will the price floor create excess supply or excess demand? d. How much? million pounds e. Compute the quantity of peanuts actually sold with the price floor. million pounds f. Does consumer surplus increase or decrease as a result of the price floor,

as compared to the free market in question (1)?

g. By how much? $ million h. Assume (optimistically) that the lowest-cost peanut producers do all the

selling. Does producer surplus increase or decrease as a result of the price floor, as compared to the free market in question (1)?

i. By how much? $ million j. Compute the deadweight loss (or loss of total social welfare) caused by the

price floor, as compared to the free market in question (1). $ million

(3) [Quota: 24 pts] Suppose the price floor is removed and instead the government imposes a quota on peanut producers of 6 million pounds. It does this by issuing permits to producers. Each permit allows the producer to sell one pound of peanuts. Permits are issued to producers for free.

a. Compute the equilibrium price of peanuts with the quota. $ per pound b. Does consumer surplus increase or decrease as a result of the quota, as

compared to the free market in question (1)?

c. By how much? $ million d. Assume (optimistically) that the permits go to the lowest-cost peanut

producers. Does producer surplus increase or decrease as a result of the quota, as compared to the free market in question (1)?

e. By how much? $ million f. Compute the deadweight loss (or loss of total social welfare) caused by the

quota, as compared to the free market in question (1). $ million

[end of exercise]