******* Question-1 *******
Suppose that the
U.S. Department of Agriculture (USDA) administers the price floor for
cheese, set at $0.17 per pound of cheese. (In real life, the actual
price floor was officially set at $16.10 per hundredweight of cheese.
One hundredweight is 100 pounds.) At that price, according to data from
the USDA, the quantity of cheese produced in 2009 by U.S. producers was
212.5 billion pounds, and the quantity demanded was 211 billion pounds.
To support the price of cheese at the price floor, the USDA had to buy
up 1.5 billion pounds of cheese. The accompanying diagram shows supply
and demand curves illustrating the market for cheese.
a.
In the absence of a price floor, the maximum price that a few of the
consumers are willing to pay is $0.20 for a pound of cheese whereas the
market equilibrium price is $0.13 per pound. The graph also shows that
the minimum price at which a few of the producers are willing to sell is
$0.06 per pound. In the absence of a price floor, how much consumer
surplus is created?
b. How much producer surplus?
c. What is the total surplus
d. The maximum price that a few of the consumers are willing to pay is
$0.20 per pound of cheese, and the price floor is set at $0.17 per
pound. With the price floor at $0.17 per pound of cheese, consumers buy
211 billion pounds of cheese. How much consumer surplus is created now?
e. The minimum price at which a few of the producers are willing to
sell a pound of cheese is $0.06, and the price floor is set at $0.17 per
pound. With the price floor at $0.17 per pound of cheese, producers
sell 212.5 billion pounds of cheese (some to consumers and some to the
USDA). How much producer surplus is created now?
f. The surplus
cheese USDA buys is the difference between the quantity of cheese
producers sell (212.5 billions of pounds of cheese) and the quantity of
cheese consumers are willing to buy at the price floor (211 billions of
pounds of cheese). How much money does the USDA spend on buying up
surplus cheese?
g. Taxes must be collected to pay for the
purchases of surplus cheese by the USDA. As a result, total surplus
(producer plus consumer) is reduced by the amount the USDA spent on
buying surplus cheese. Using your answers for parts b—d, what is the
total surplus when there is a price floor?
h. How does this compare to the total surplus without a price floor from part a?
******* Question-2 *******
The accompanying table shows the price and yearly quantity sold of ice cream cones on Sidfield Island.
Price of Ice Cream Cones Quantity of Ice Cream Cones Demanded
$1 3000
$2 2400
$3 1600
$4 800
a. Using the midpoint method (show your work), calculate the price
elasticity of demand when the price of an ice cream cone rises from $1
to $2.
b. What does this estimate imply about the price elasticity of demand for ice cream cones?
c. Using the midpoint method (show your work), calculate the price
elasticity of demand when the price of an ice cream cone rises from $3
to $4.
d. What does this estimate imply about the price elasticity of demand for ice cream cones?
e. Notice that the estimates from (a) and (b) above are different. Why
do price elasticity of demand estimates change along the demand curve?
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