Government Actions in Markets
Practice Questions
ECON2113 Microeconomics (L1/L7)
Tutorial Five
Jeremy TO
Department of Economics, HKUST
Jeremy TO ECON2113 Microeconomics (L1/L7)
Government Actions in Markets
Practice Questions
Price Controls - Price Ceiling
A price ceiling is a government regulation that makes it illegal
to charge a price higher than a specified level. When a price
ceiling is applied to a housing market it is called a rent ceiling.
A rent ceiling set above the equilibrium rent has no effect on
the market (non-binding price ceiling). A rent ceiling set
below the equilibrium rent creates a housing shortage,
increased search activity, and a black market.
Rent ceilings lead to inefficiency. In a housing market with a
rent ceiling, the quantity of units available is less than the
equilibrium quantity and so is less than the efficient quantity.
The market underproduces, and there is a deadweight loss.
Jeremy TO ECON2113 Microeconomics (L1/L7)
Government Actions in Markets
Practice Questions
Price Controls - Price Floor
A price floor is a government-imposed regulation that makes
it illegal to charge a price lower than a specified level.
When a price floor is applied to labor markets, it is called a
minimum wage. A minimum wage that is set above the
equilibrium wage rate creates unemployment.
Fewer workers are employed with a minimum wage, so less
than the efficient quantity of workers is employed. Therefore,
it creates a deadweight loss.
Jeremy TO ECON2113 Microeconomics (L1/L7)
Government Actions in Markets
Practice Questions
Price Controls - Diagrams
Jeremy TO ECON2113 Microeconomics (L1/L7)
Government Actions in Markets
Practice Questions
Taxes
Tax Incidence is the division of the burden of a tax between
the buyer and the seller.
The buyers’ burden arises when the price paid by the buyers
rises after the tax is imposed.
The sellers’ burden arises when the price they receive falls
after the tax is imposed.
Tax incidence does not depend on whether the tax law
imposes the tax on buyers or on sellers.
Imposing a tax on sellers decreases supply because the tax
is like a cost that sellers must pay. The supply curve shifts
upward. The price paid by buyers rises, the price received by
sellers falls, and the quantity decreases.
Imposing a tax on buyers decreases demand because the tax
lowers the amount they are willing to pay to the sellers. The
demand curve shifts downward. The price paid by buyers rises,
the price received by sellers falls, and the quantity decreases.
Jeremy TO ECON2113 Microeconomics (L1/L7)
Taxes
Equivalence of Tax on Buyers and Sellers: The tax burden
is split the same way regardless of who is responsible for
paying the tax to the government.
Tax incidence depends on relative price elasticity of
demand and supply.
When supply is more elastic than demand, buyers bear most of
the tax burden.
When demand is more elastic than supply, producers bear most
of the cost of the tax.
Taxes drive a wedge between the price buyers pay and sellers
receive. The quantity produced is less than the efficient
quantity. Therefore, imposition of taxes creates deadweight
loss.
Taxes - Diagrams
Government Actions in Markets
Practice Questions
Global Markets in Actions
Jeremy TO ECON2113 Microeconomics (L1/L7)
Government Actions in Markets
Practice Questions
Tariff and Quota
Jeremy TO ECON2113 Microeconomics (L1/L7)
Government Actions in Markets
Practice Questions
Problem 1
A market is described by the following supply and demand curves:
Q s = 2P
Q d = 300 − P
(1) Solve for the equilibrium price and quantity.
(2) If the government imposes a price ceiling of $90, does a
shortage or surplus (or neither) develop? What are the price,
quantity supplied, quantity demanded, and size of the shortage
and surplus?
(3) If the government imposes a price floor of $90, does a
shortage or surplus (or neither) develop? What are the price,
quantity supplied, quantity demanded, and size of the shortage
and surplus?
Jeremy TO ECON2113 Microeconomics (L1/L7)
Problem 1
(4) Instead of a price control, the government levies a tax on
producers of $30. As a result, the new supply curve is:
Q s = 2(P − 30)
Does a shortage or surplus (or neither) develop? What are the
price, quantity supplied, quantity demanded, and size of the
shortage or surplus?
(5) Instead of imposing a tax on producers, now suppose a tax
of T is placed on buyers, derive the new demand curve and
solve for the new equilibrium. What happens to the price
received by sellers, the price paid by buyers, and the quantity
sold?
(6) Tax revenue is T × Q. Use your answer from part (5) to
solve for tax revenue as a function of T . Graph this
relationship for T between 0 and 300.
Problem 1
(7) The deadweight loss of a tax is the area of the triangle
between the supply and demand curve. Solve for deadweight
loss as a function of T. Graph this relationship for T between 0
and 300.
(8) The government now levies a tax of $200 per unit on this
good. Is this a good policy? Why or why not? Can you
propose a better policy?
Government Actions in Markets
Practice Questions
Problem 2
The world producer price for baseballs is $24 per dozen, and almost
all of them are produced outside the United States. Suppose the
U.S. demand curve is Q d = 100000 − 2000P , where P is price per
dozen, and Q is measured in dozens. The U.S. domestic supply
curve is Q s = −10000 + 1, 000P.
(1) Before a tariff is imposed, what is the U.S. equilibrium
price? Domestic consumption? Domestic production?
Imports?
(2) Congress has decided to help the baseball manufacturing
industry for national security reasons, and it imposes a tariff of
$6 per dozen. What are the new equilibrium price, domestic
consumption, domestic production, and imports?
(3) What are the losses to U.S. consumers, gains to U.S.
producers, and deadweight loss?
Jeremy TO ECON2113 Microeconomics (L1/L7)
