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UW-Madison ECON 101 - Answers to Quiz #2

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Economics 101 Name __________________________________Summer 2011Answers to Quiz #2May 31, 2011Please write legibly and neatly in answering this quiz. Remember that we reserve the right to count an answer as wrong if we cannot read it. 1. For each of the following scenarios identify what the effect is on the equilibrium price and equilibrium quantity. Assume that each market is initially in equilibrium.a. (2 points) Consider the market for orange juice. Suppose that the Surgeon General releases a report thatshows that drinking orange juice daily increases life expectancy by four years. At the same time suppose that there is a cold snap in Florida that severely damages this year’s orange crop. Given these changes andholding everything else constant, in the market for orange juice the equilibrium price will ________increase_____________________ and the equilibrium quantity will ________be indeterminate_________.b. (2 points) Consider the market for artisanal cheese (this is handmade, high-quality cheese manufactured by local producers). Suppose that people are convinced that locally sourced food products are better for them than mass produced foods. Given this belief and holding everything else constant, in the market for artisanal cheese we can expect the equilibrium price to _______increase_________ and theequilibrium quantity to _______increase_____________.c. (2 points) Consider the market for student apartments in Madison. Suppose that recently a number of new buildings with student apartments have been erected in the downtown area. Given this change and holding everything else constant, in the market for student apartments in Madison we can expect the equilibrium price to _____decrease_______________ and the equilibrium quantity to ______increase___________.2. (2 points) Suppose that there are five identical producers in the market for gadgets. The supply curve for one producer is given by the equation Q = 10 + 2P. Assuming that each of these firms are identical, provide the equation in slope intercept form of the market supply curve. First, rewrite the firm supply curve in slope intercept form: P = ½ Q – 5. Then, think about two points on this line: for example, (Q, P) = (30, 10) and (50, 20). But, now you need to incorporate that there are five firms: so if one firm is willing to supply 30 units at a price of $10, then five identical firms will supply 150 units at a price of $10. A second point can be similarly found: if one firm will supply 50 units at a price of $20, then five identical firms will supply 250 units at a price of $20. Thus, the points (250, 20) and (150, 10) are on the market supply curve. With two points you can write the equation for this line as P= 1/10Q + b or P = 1/10Q – 5.13. Consider the market for corn. Suppose that the demand curve for corn is given by the equation P = 1000 – Q while the supply curve for corn is given by the equation P = 3Q where P is the price per unit of corn and Q is units of corn.a. (2 points) What is the equilibrium price and quantity in the corn market?The equilibrium price in this market is $750 and the equilibrium quantity is 250 units. b. (2 points) Suppose the government decides to institute a price floor in the corn market. For this price floor to be effective what must be true about it?To be effective the price floor must be set at a level that is greater than the equilibrium price in the market, or greater than $750.c. Suppose the government decides to institute a price floor in the corn market and sets this price floor equal to $780. Furthermore, suppose the government plans to purchase any surplus corn that is produced under this program. Given this information answer the following questions:i. (2 points) How many units of corn will consumers purchase given this price floor?With the price floor set at $780 consumers will produce 220 units of corn: P = 1000 – Q and if P is equal to 780, then 780 = 1000 – Q or Q = 220.ii. (2 points) How many units of corn will the government purchase given this price floor?With the price floor set at $780 farmers will be willing to supply 260 units. To see this use the supply equation: P = 3Q and replace P with 780. Thus, 780 = 3Q or Q = 260. Since demanders want 220 units of corn at a price of $780, this implies that the government will need to purchase the difference between the amount supplied, 260, and the amount demanded, 220. The government will therefore purchase 40 units of corn. iii. (2 points) Suppose that the cost to store a single unit of corn is $100. What is the total cost including storage cost to the government of this program?The government will purchase 40 units of corn at a price of $780 per unit of corn, or $31,200. The cost of storage will be equal to ($100 per unit of corn)(40 units of corn) or $4000. Total cost is therefore equal to $35,200.d. (2 points) Suppose instead of the price floor program described in part (c) the government decides to institute a price guarantee or subsidy for the production of corn. If they wish to maintain production at thesame level as it was with the price floor how big of a subsidy per unit will be needed? If the government institutes a price guarantee to replace the price floor of $7780 they are effectively saying that they are guaranteeing that the price of corn will be $780 once the government augments the price that consumers pay. Farmers given this guaranteed price will want to produce 260 units of corn. To sell 260 units of corn they will need to sell each unit for $740. The difference between the guaranteed price of $780 and the price consumers are willing to pay of $740 is the subsidy per unit. In this case the subsidy per unit will be $40. 24. Consider the market for cheese in Dairyland. The market demand and supply curves are given by the equations:Demand: P = 80 – 2QSupply: P = 40 + 2Qa. (1 point) In equilibrium, what is the value of consumer expenditure in this market?Consumer expenditure is equal to price times quantity. In this example, the equilibrium price is $60 per unit and the equilibrium quantity is 10 units, so the consumer expenditure is equal to $600. b. (2 points) In equilibrium, what is the value of consumer surplus in this market?Consumer surplus is equal to the area under the demand curve but above the price that consumers pay for the good. In this problem, CS = (1/2)($80 per unit - $60 per unit)(10 units) = $100.c. (2 points ) In equilibrium, what is the value of producer surplus in this


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UW-Madison ECON 101 - Answers to Quiz #2

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