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Berkeley ECON 100A - Econ 100A Homework Suggested Solutions

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The Public Service Company of Colorado has a 70% market share in electric utilities in Colorado (http://www.eere.energy.gov/electricity_restructuring/weekly/oct29_99.html).Economics 100A Homework #4 Suggested Solutions QUESTION #1 In order to answer this question, I will make the assumption that the supply curve is perfectly inelastic. This is a reasonable assumption to make. Recall that the supply curve is the upward-sloping portion of the marginal cost curve. What is the marginal cost of producing one additional ticket, or allowing one more person to enter the concert? Virtually negligible. A rock concert is a production with a very high fixed cost and very low marginal cost. Once the fixed cost is incurred (the cost of the venue, employees to set up the stage, etc.), the average variable cost is virtually zero. Supply is constrained, however, at the capacity of the venue. In this case, capacity is 10,000. If the demand curve were perfectly elastic, and each of the 25,000 fans were willing to pay exactly $280 and only had to pay $75 for the ticket, the consumer surplus would be ($280-$75)*10,000=$2,050,000. This is shown in the graph above at the left. Realistically, however, the demand curve would probably be downward-sloping, meaning that some concert-goers have a higher valuation than others. This results in the larger consumer surplus in the graph at the right. The consumer surplus created by this ticket price has a lower bound of $2,050,000. The ticket revenue, in any case, is $75*10,000 = $750,000. Note that Bruce could have priced the tickets at $280 and taken all of the surplus for himself, and the revenue would have been $280*10,000 = $2,800,000. It appears he really did give value to his fans. (Though his real motive may be to promote his new CD.) D 280 S 10,000 q 75 p, $ CSDownward-Sloping Demand Curve p, $ SPerfectly Elastic Demand Curve 280 D CS 75 q 10,000QUESTION #2 The effect of a subsidy on supply and demand is analogous to that of a tax. Like a tax, a subsidy creates a wedge between supply and demand. This is depicted in the diagram below. Unlike a tax, the quantity that is produced and sold is greater than the equilibrium quantity. Price S(q) Kp* + s BH FJpeqm GI A CDp* E D(q) Quantity No Subsidy Subsidy Change Consumer Surplus, CS B + F + K A + B + C + D + F + G + K A + C + D + G Producer Surplus, PS A + E + G A + B + E + F + G + H B + F + H Government Expense, -X 0 - A - B - C - D - F - G - H - I - J 0 - A - B - C - D - F - G - H - I – J Welfare, W = CS + PS – X B + F + K + A + E + G K + A + B + E + F + G - I - J - I – J = DWL Like a tax, the implication of a subsidy is that society is worse off in terms of welfare. QUESTION #3 By imposing a restriction on new billboards, the government is essentially making the industry less competitive by eliminating the threat of entry. By blocking entry and eliminating potential future competition, the government has increased the value of existing billboards. Hence, it is not surprising that producers of existing billboards are not contesting the policy. They will be able rent or sell billboards to advertisers at a higher rate in the future than they would without the ban. Consumers of billboards in this example are advertisers; producers are those firms who are producing billboards.QUESTION #4 Let quantity be the number of visitors at Yellowstone National Park. The park service can limit the number of visitors to Q* by setting the price at p*, or using a lower price, p**, and set the quota at Q*. With the high price, the consumer surplus is A. With the lower price and the quota, the consumer surplus is A + B. Presumably the park service limits entry because it worries about wear and tear on the park or to reduce congestion in the park to make visits better. Thus, to determine the full welfare effects are complicated. Q* qeqm Number of visitors to park Price Ap* B p** D(q) QUESTION #6 Rent Control: price set at p*.Price S(q) B Fpeqm G A CDp* E D(q) 0 q* qeqm Apartments per Month (Quantity of Housing Consumed): q* - qeqm o consumer surplus change is A – F. People who find cheap rentals, benefit. However, ubsidy: ∆∆(Consumer Surplus): (A + B) – (B + F) = A - F∆(Producer Surplus): E – (E + A + G) = -A - G Deadweight Loss: -F - G Speople who cannot find rental units at p* may waste time search unsuccessfully for housing. Producers unambiguously lose. SPrice S(q) K BH FJpeqm GI A CDp* E D(q) 0 q* qeqm q** Apartments per Month ∆(Quantity of Housing Consumed): q** - qeqm ∆(Consumer Surplus): (A + B + C + D + F + G + K) – ( B + F + K) = A + C + D + G ∆(Producer Surplus): (A + B + E + F + G + H) – (A + E + G) = B + F + H ∆(Government Expenditure): 0 – (A + B + C + D + F + G + H + I + J) Deadweight Loss: -I - J Thus, consumers gain, producers gain, and the government or tax payers lose. As supply becomes more elastic, the deadweight loss in the rent control case (subsidy case) becomes larger (smaller). As demand becomes more elastic, the opposite occurs. QUESTION #7 The government sets a support price, p. Producers decide how much to supply at p. The government then gives the producers a deficiency payment equal to the difference between the support and actual prices, p – p*, for every unit sold so that the producers actually receive the support price for the goods sold.Price S(q) Kp BH FJpeqm GI A CDp* E D(q) 0 q* qeqm q Quantity Demand: Qd = a – bp Supply: Qs = b + dp peqm solves Qd = Qs => a – bpeqm = b + dpeqm => peqm = (a – b)/(b + d) Ö qeqm = a – b[(a – b)/(b + d)] = [a(b + d) – b(a – b)]/(b + d) = (ad + b2)/(b + d) No Price Support Price Support Change Consumer Surplus, CS B + F + K A + B + C + D + F + G + K A + C + D + G Producer Surplus, PS A + E + G A + B + E + F + G + H B + F + H Government Expense, -X 0 - A - B - C - D - F - G - H - I - J 0 - A - B - C - D - F - G - H …


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Berkeley ECON 100A - Econ 100A Homework Suggested Solutions

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