Microeconomics CH-6 - chapter 6 solutions PDF

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Microeconomics Chapter 6 Quick Check Multiple Choice 1.

When the government imposes a binding price floor, it causes

a. the supply curve to shift to the left. b. the demand curve to shift to the right. c. a shortage of the good to develop. d. a surplus of the good to develop. Step-by-step solution 1. Step 1 of 3 Price floor refers to the legally established minimum price that can be charged for a good. However, price above the price floor can be charged. A price floor can be binding only if the price floor is above the equilibrium price because in case it is below the equilibrium price then on account of reason that higher price than price floor can be charged, sellers will indeed charge equilibrium price and purpose of establishing price floor will be defeated. Thus, binding price floor is always above the equilibrium price. 2. Step 2 of 3 As one knows that at any price above the equilibrium price, supply exceeds the demand and situation of surplus gets created. So, binding price floor by virtue of being above the equilibrium price also creates surplus. 3. Step 3 of 3 Hence, the correct answer is option (d). 2. In a market with a binding price ceiling, an increase in the ceiling will ___________ the quantity supplied, ___________ the quantity demanded, and reduce the ___________. a. increase, decrease, surplus b. decrease, increase, surplus c. increase, decrease, shortage d. decrease, increase, shortage Step-by-step solution 1. Step 1 of 3 Price ceiling refers to the legally established maximum price that can be charged for a good. However, price below the price ceiling can be charged. A price ceiling can be binding only if the price ceiling is below the equilibrium price because in case it is above the equilibrium price then on account of reason that lower price than price ceiling can be charged, sellers will charge equilibrium price as it will result in more sale and revenue. Thus, binding price ceiling is always below the equilibrium price. 2. Step 2 of 3

As one knows that any price below the equilibrium price, demand exceeds the supply and situation of shortage gets created. It should also be noted that as one starts from any price that is below the equilibrium price and moves towards the equilibrium price, quantity demanded gets decreases while quantity supplied gets increases and shortage reduces. Since, binding price ceiling is below the equilibrium price, any increase in it will increase the quantity supplied, decrease the quantity demanded and reduce the shortage. 3. Step 3 of 3 Hence, the correct answer is option (c). 3.

A $1 per unit tax levied on consumers of a good is equivalent to

a. a $1 per unit tax levied on producers of the good. b. a $1 per unit subsidy paid to producers of the good. c. a price floor that raises the good’s price by $1 per unit. d. a price ceiling that raises the good’s price by $1 per unit. Step-by-step solution 1. Step 1 of 2 If one analyzes the scenario where tax is levied on the buyer or where tax is levied on the seller then it can be seen that irrespective of the tax being levied on seller or buyers wedge that the tax creates between the buyer’s price and seller’s price remains same. In other words, both buyers and sellers share the burden of tax as wedge created by tax relatively shift the position of both demand and supply curve respectively. Thus, tax whether levied on seller or buyer is equivalent in their overall impact. 2. Step 2 of 2 Hence, the correct answer is option (a). 4. Which of the following would increase quantity supplied, decrease quantity demanded, and increase the price that consumers pay? a. the imposition of a binding price floor b. the removal of a binding price floor c. the passage of a tax levied on producers d. the repeal of a tax levied on producers Step-by-step solution 1. Step 1 of 3 The situation described in question can only happen if the biding price floor is imposed. This is because a price floor is only binding when it is above the equilibrium price. So, if binding price floor is imposed it will raise the price of good. 2. Step 2 of 3 As one knows that quantity supplied and price has direct relationship whereas quantity demanded and price has inverse relationship. So, this rise in price due to binding price floor will increase the quantity supplied and decrease the quantity demanded. As binding price floor is above the equilibrium price, its imposition will definitely increase the price that consumers pay that hitherto is paying the equilibrium price.

3. Step 3 of 3 Hence, the correct answer is option (a). 5. Which of the following would increase quantity supplied, increase quantity demanded, and decrease the price that consumers pay? a. the imposition of a binding price floor b. the removal of a binding price floor c. the passage of a tax levied on producers d. the repeal of a tax levied on producers Step-by-step solution 1. Step 1 of 2 The situation described in question can only happen if tax levied on producers is taken back. This is because when tax is levied on producer it raise their cost of production and if it is taken back it will reduce their cost of production and thus prompt them to increase the quantity supplied at every price or supply curve will shift rightwards. As tax is related to seller, its levying or repeal will have no impact on position of demand curve. So, with position of demand curve remaining unchanged, this rightward shift of supply curve will lead to fall in equilibrium price. This fall in price means consumers will pay less. As price and quantity demanded has inverse relationship, this fall in price means increase in quantity demanded. 2. Step 2 of 2 Hence, the correct answer is option (d). 6.

When a good is taxed, the burden of the tax falls mainly on consumers if

a. the tax is levied on consumers. b. the tax is levied on producers. c. supply is inelastic, and demand is elastic. d. supply is elastic, and demand is inelastic. Step-by-step solution 1. Step 1 of 2 Whenever a tax is levied on any good, its burden falls on both buyers and sellers. However, magnitude of burden depends on the respective elasticity of demand and supply of the given good. For instance, if demand for given good is less elastic or inelastic while supply is more elastic or elastic then major burden of tax will fall on buyers. On the other hand, if demand for good is more elastic or elastic while supply is less elastic or inelastic then major burden of tax will fall on sellers. 2. Step 2 of 2 Hence, the correct answer is option (d).

Questions for Review 1. Give an example of a price ceiling and an example of a price floor. Step-by-step solution 1. Step 1 of 2 Price floors sets a minimum price limit on the price of the commodity. It means the price can't go lower than the price set. An effective price floor is where equilibrium price is below the price floor. This will create surplus in the market. The example of price floor is minimum wage law. 2. Step 2 of 2 Price ceiling puts a maximum price limit on the price of the commodity. It means the price can't go higher than the price set. An effective price ceiling is where equilibrium price is above the price floor. This will create shortage in the market. The example of price ceiling is rent control law. 2. Which causes a shortage of a good—a price ceiling or a price floor? Justify your answer with a graph. Step-by-step solution 1. Step 1 of 2 771-6-2RQ SA: 3975 Price ceiling will cause shortage of a good.

Price ceiling: Is the maximum price that a seller can charge on his product. When this price is above the equilibrium price Pe than it shows no effect, if it is below the market equilibrium price Pe, than it shows effect on the supply of the product. Here the ceiling price is below the market price, at this price customers demand is Qd, but the suppliers are willing to supply only Qs quantity, resulting into a shortage in the market. Shortage can be calculated by Qd- Qs. 2. Step 2 of 2

When there is a price floor, which is binding, than the price that can be charged is well above the market equilibrium price. At this price suppliers are willing to supply more at Qs, but the demand is only Qd. Resulting into a surplus in the market. 3. What mechanisms allocate resources when the price of a good is not allowed to bring supply and demand into equilibrium? Step-by-step solution 1. Step 1 of 1 When the price of a good is not allowed to bring supply and demand into equilibrium, some alternative mechanisms develop for rationing. If the quantity supplied exceeds the quantity demanded such that there is a surplus of a good (as in the case of a binding price floor), sellers may try to appeal to the personal biases of the buyers. If the quantity demanded exceeds the quantity supplied such that there is a shortage of a good (as in the case of a binding price ceiling), sellers can ration the good according to their personal biases, or make buyers wait in line. Suppose there is a shortage of ice cream, buyers who are willing to come early and wait in queues will get it and those who are not willing, do not get it. Still, the long lines will be there. Rationing also is discriminatory. Sellers could sell the good to only friends or relatives. 4. Explain why economists usually oppose controls on prices. Step-by-step solution 1. Step 1 of 1 Economists usually oppose price control because for them, prices are not the outcome of some haphazard process. Instead, prices are the result of the millions of business and consumer decisions that lie behind supply and demand factors. Prices balance supply and demand, thus coordinating economic activity. When price controls are imposed, they observe the signals that normally guide the allocation of society’s resources. Even though price controls are often aimed at helping the poor, they often hurt those they are trying to help. For example, rent control laws try to make housing affordable for everyone, but to find a well-maintained house will be difficult.

Similarly, minimum-wage laws may raise the income of workers. However, they also cause other workers to be unemployed. It is for the above reasons that economists criticize price control. 5. Suppose the government removes a tax on buyers of a good and levies a tax of the same size on sellers of the good. How does this change in tax policy affect the price that buyers pay sellers for this good, the amount buyers are out of pocket including the tax, the amount sellers receive net of tax, and the quantity of the good sold. Step-by-step solution 1. Step 1 of 2 If the government removes a tax on the buyers of a good and levies a tax of the same size on the sellers of the good, then regardless of who pays the tax the outcome will be the same. 2. Step 2 of 2 This is because a tax on a good places a wedge between the price received by the sellers and the price paid by the buyers. Furthermore, if buyers pay the tax then there will be a shift in the demand curve; on the other hand, a tax paid by sellers shifts the supply curve. Therefore, when the market moves to new equilibrium due to tax the buyers pay more for the good and sellers receive less. Thus, on whomever the tax is levied the tax burden will be shared among the sellers and buyers without any change in the outcome achieved due to the tax. 6. How does a tax on a good affect the price paid by buyers, the price received by sellers, and the quantity sold? Step-by-step solution 1. Step 1 of 1 A tax on a good raises the price that the buyers pay, lowers the price that the sellers receive, and reduces the quantity sold. 7. What determines how the burden of a tax is divided between buyers and sellers? Why? Step-by-step solution 1. Step 1 of 1 It is price elasticity of supply and demand that determines how the burden of a tax is divided between buyers and sellers. The burden of a tax tends to fall more heavily on the side of the market that is less elastic because that side of the market can respond less easily to the tax by changing the quantity bought and sold. Elasticity measures the willingness of buyers and sellers to leave the market when conditions become unfavorable. A small elasticity of demand means that buyers do not have good alternatives to consuming this particular good. A small elasticity of supply means that sellers do not have good alternatives to producing this particular good. So when the good is taxed, the side of the market with fewer good alternatives cannot easily leave the market and must, therefore, bear more of the tax burden....