PGP-I

Problem Set
(Selected from B-B)

1. Consider the market for crude oil. Suppose the demand curve is described by Qd = 100
P, where Qd is the quantity buyers will purchase when the price they pay is P (measured
in dollars per barrel). The equation representing the supply curve is QS= P/3, where QS is
the quantity that producers will supply when the price they receive is P.
crude oil is initially in equilibrium, with no tax and no subsidy.

The market for

Because it regards the

price of oil as too high, the government wishes to help buyers by announcing that it will
give producers a subsidy of 4 dollars per barrel. A local television station reporter
announces that the subsidy should lower the price consumers pay by 4 dollars per barrel.
Analyze the reporters claim by determining the price buyers pay before and after the
subsidy, and provide intuition to explain why the reporter is correct or incorrect.

2. In a competitive market, there is currently no tax, and the equilibrium price is $60. The
market has a downward-sloping demand curve. The government is about to impose an
excise tax of $4 per unit. In the new equilibrium with the tax, what price will producers
receive and consumers pay if the supply curve is
a) Perfectly elastic
b) Perfectly inelastic

3. Assume that a competitive market has an upward-sloping supply curve and a

downward-sloping demand curve, both of which are linear. A tax of size $T is currently
imposed in the market. Suppose the tax is doubled. By what multiple will the deadweight
loss increase? (You may assume that at the new tax, the equilibrium quantity is positive.)

4. In a perfectly competitive market, the market demand curve is given by Qd = 200 5Pd,
and the market supply curve is given by Qd = 35Ps.
a) Find the equilibrium market price and quantity demanded and supplied in the absence
of price controls.
b) Suppose a price ceiling of $2 per unit is imposed. What is the quantity supplied with a
price ceiling of this magnitude? What is the size of the shortage created by the price
ceiling?
c) Find the consumer surplus and producer surplus in the absence of a price ceiling. What
is the net economic benefit in the absence of the price ceiling?
d) Find the consumer surplus and producer surplus under the price ceiling. Assume that
rationing of the scarce good is as efficient as possible. What is the net economic benefit in
this case? Does the price ceiling result in a deadweight loss? If so, how much is it?
e) Find the consumer surplus and producer surplus under the price ceiling, assuming that
the rationing of the scarce good is as inefficient as possible. What is the net economic
benefit in this case? Does the price ceiling result in a deadweight loss? If so, how much is
it?

5. In a perfectly competitive market, the market demand and market supply curves are
given by Qd = 1000 10Pd and Qd = 30Ps. Suppose the government provides a subsidy of
$20 per unit to all sellers in the market.
a) Find the equilibrium quantity demanded and supplied; find the equilibrium market
price paid by buyers;
find the equilibrium after-subsidy price received by firms.
b) Find the consumer surplus and producer surplus in the absence of the subsidy. What is
the net economic benefit in the absence of a subsidy?
c) Find the consumer surplus and producer surplus in the presence of the subsidy. What is
the impact of the subsidy on the government budget? What is the net economic benefit
under the subsidy program?
d) Does the subsidy result in a deadweight loss? If so, how much is it?

6. In a perfectly competitive market, the market demand curve is Qd = 10 Pd, and the
market supply curve is Qs = 1.5Ps.
a) Verify that the market equilibrium price and quantity in the absence of government
intervention are Pd = Ps = 4 and Qd = Qs = 6.
b) Consider two possible government interventions: (1) A price ceiling of $1 per unit; (2)
a subsidy of $5 per unit paid to producers. Verify that the equilibrium market price paid
by consumers under the subsidy equals $1, the same as the price ceiling. Are the
quantities supplied and demanded the same under each government intervention?
c) How will consumer surplus differ in these different government interventions?
d) For which form of intervention will we expect the product to be purchased by
consumers with the highest willingness to pay?
e) Which government intervention results in the lower deadweight loss and why?

7. Consider a perfectly competitive market in which the market demand curve is given by
Qd = 20 2Pd and the market supply curve is given by Qs = 2Ps.
a) Find the equilibrium price and quantity in the absence of government intervention.
b) Suppose the government imposes a price ceiling of $3 per unit. How much is supplied?
c) Suppose, as an alternative, the government imposes a production quota limiting the
quantity supplied to 6 units. What is the market price under this type of intervention? Is
the quantity supplied under the price ceiling greater than, less than, or the same as the
quantity under the production quota?
d) Assuming that under price controls rationing is as efficient as possible and under the
quota, the allocation is as efficient as possible, under which program is the deadweight
loss larger: the price ceiling or the production quota?
e) Assuming that under price controls rationing is as inefficient as possible, while under
the quota the allocation is as efficient as possible, under which program is the deadweight
loss larger: the price ceiling or the production quota?