CHAPTER 6: SUPPY, DEMAND AND GOVERNMENT POLICIES

1. Lovers of classical music persuade Congress to impose a price ceiling of $40 per
concert ticket. As a result of this policy, do more or fewer people attend classical
music concerts? Explain.
If the price ceiling of $40 per ticket is less than the equilibrium price, the quantity
required will outnumber the quantity provided, resulting in ticket shortage. The amount
given is reduced due to the lower price. So as the result, the policy reduces the number of
individuals who attend classical music events.
2. The government has decided that the free-market price of cheese is too low.
a. Suppose the government imposes a binding price floor in the cheese market. Draw a
supply and demand diagram to show the effect of this policy on the price of cheese and
the quantity of cheese sold. Is there a shortage or surplus of cheese?

Figure 1.
Figure 1 depicts the establishment of a binding price floor in the cheese market. When
there is no price floor, the price would be P 1 and the quantity would be Q1. When the price
floor is set, which is greater than P1, the quantity demanded is Q2, while the quantity
supplied is Q3. As the result, there will be a surplus of cheese, which in the amount of Q 3
minus Q2.
b. Producers of cheese complain that the price floor has reduced their total revenue. Is
this possible? Explain.
Complaint of producer of cheese that the price floor has reduced their total revenue is
possible because demand is elastic. With elastic demand, the percentage decrease in
quantity would exceed the percentage increase in price, resulting in a decrease in total
revenue.
c. In response to cheese producers’ complaints, the government agrees to purchase all
the surplus cheese at the price floor. Compared to the basic price floor, who benefits
from this new policy? Who loses?
If the government agrees to purchase all the surplus cheese at the price floor, cheese
producers benefit and taxpayers lose:
 Cheese producers benefit from the policy because producers would create amount
Q3 of cheese, resulting in a significant rise in overall revenue.
 Taxpayers lose because greater taxes would be used to finance the purchase of the
surplus cheese.

3. A senator wants to raise tax revenue and make workers better off. A staff
member proposes raising the payroll tax paid by firms and using part of the extra
revenue to reduce the payroll tax paid by workers. Would this accomplish the
senator’s goal? Explain.
This policy would accomplish the senator’s goal, as reducing the payroll tax paid by
firms and using part of the extra revenue to reduce the payroll tax paid by workers would
not benefit workers since the sharing of the burden of a tax is determined by the elasticity
of supply and demand, not who must pay the tax. Because the tax wedge would be wider,
it is likely that both enterprises and employees, who bear the brunt of any tax, would
suffer.

4. If the government places a $500 tax on luxury cars, will the price paid by
consumers rise by more than $500, less than $500, or exactly $500? Explain.
If the government imposes a $500 tax on luxury cars, the price paid by consumers will
rise less than $500. Any tax burden is shared by both producers and consumers:
consumers pay higher prices, while producers receive lower prices, with the difference
between the two equal to the tax amount. The only exceptions would be if the supply or
demand curves were fully elastic or inelastic, in which case consumers would shoulder
the whole tax burden and the price paid by consumers would increase by precisely $500.
5. Congress and the president decide that the United States should reduce air
pollution by reducing its use of gasoline. They impose a $0.50 tax on each gallon of
gasoline sold.
a. Should they impose this tax on producers or consumers? Explain carefully using a
supply-and-demand diagram.

The effect will be the same whether the tax is imposed on producers or consumers. With
no tax, the demand curve is D1 and the supply curve is S1, as illustrated in the figure. If
the tax is imposed on producers, the supply curve swings up to S2 by the amount of the
tax ($0.50). The equilibrium quantity is Q2, the price paid by consumers is P2, and the
price received by producers (after taxes) is equal to P2 minus $0.50. If the tax is instead
imposed on consumers, the demand curve moves downward by $0.50 to D2. When a tax
is imposed on consumers, the downward shift in the demand curve is the same size as the
upward movement in the supply curve when the tax is imposed on producers. As a result,
the equilibrium quantity is Q2, the price paid by consumers is P2 (including the
government tax), and the price received by producers is P2 minus $0.50.
b. If the demand for gasoline were more elastic, would this tax be more effective or less
effective in reducing the quantity of gasoline consumed? Explain with both words and
a diagram.
The more elastic the demand curve, the more effective this tax will be in reducing
gasoline use. Greater demand elasticity indicates that quantity declines more in reaction
to a rise in gasoline prices. This is seen in the image above. Demand curve D1 is an
elastic demand curve, whereas demand curve D2 is a more inelastic demand curve. To
achieve the same tax wedge between demand and supply, demand curve D1 requires a
bigger drop in quantity than demand curve D2.
c. Are consumers of gasoline helped or hurt by this tax? Why?
The consumers of gasoline are hurt by the tax because they get less gasoline at a higher
price.
d. Are workers in the oil industry helped or hurt by this tax? Why?
Workers in the oil industry are hurt by the tax as well. Some people may lose their
employment if the amount of gasoline produced decreases. Workers' salaries may fall as a
result of a reduced price obtained by producers.

6. A case study in this chapter discusses the federal minimum-wage law.

a. . Suppose the minimum wage is above the equilibrium wage in the market for
unskilled labor. Using a supply-and-demand diagram of the market for unskilled
labor, show the market wage, the number of workers who are employed, and the
number of workers who are unemployed. Also show the total wage payments to
unskilled workers.
The graph depicts the consequences of the minimum wage. Without the minimum wage,
the market wage would be w1 and Q1 employees would be hired. When the minimum
wage (Wm) is set higher than W1, the market wage is Wm, the number of employed
workers is Q2, and the number of unemployed workers is Q3 minus Q2. Total wage
payments to unskilled workers are represented by the area of the rectangle ABCD, which
equals Wm times Q2.
b. Now suppose the secretary of labor proposes an increase in the minimum wage.
What effect would this increase have on employment? Does the change in employment
depend on the elasticity of demand, the elasticity of supply, both elasticities, or neither?
An rise in the minimum wage would reduce employment. The size of the effect on
employment is solely determined by demand elasticity. The elasticity of supply is
irrelevant since there is a labor surplus.
c. What effect would this increase in the minimum wage have on unemployment? Does
the change in unemployment depend on the elasticity of demand, the elasticity of
supply, both elasticities, or neither?
Increases in the minimum wage would result in more people becoming unemployed. The
extent of the increase in unemployment is determined by both supply and demand
elasticities. The quantity of labor requested is determined by the elasticity of demand, the
quantity of labor provided is determined by the elasticity of supply, and the difference
between the quantity supplied and demanded is the amount of unemployment.
d. If the demand for unskilled labor were inelastic, would the proposed increase in the
minimum wage raise or lower total wage payments to unskilled workers? Would your
answer change if the demand for unskilled labor were elastic?
If the demand for unskilled labor were inelastic, the proposed increase in the minimum
wage would raise total wages paid to unskilled workers. When demand is inelastic, the
percentage drop in employment is smaller than the percentage increase in wage, resulting
in an increase in total wage payments. Total wage payments would fall if demand for
unskilled labor was elastic, since the percentage reduction in employment would exceed
the percentage increase in salary.

7. At Fenway Park, home of the Boston Red Sox, seating is limited to about 38,000.
Hence, the number of tickets issued is fixed at that figure. Seeing a golden
opportunity to raise revenue, the City of Boston levies a per ticket tax of $5 to be
paid by the ticket buyer. Boston sports fans, a famously civic-minded lot, dutifully
send in the $5 per ticket. Draw a well-labeled graph showing the impact of the tax.
On whom does the tax burden fall—the team’s owners, the fans, or both? Why?
Because the supply of tickets is set at 38,000, the supply curve is totally inelastic.
Assuming a typical, downward sloping demand curve, a tax on consumers pushes the
demand curve down by a vertical distance equal to the tax amount—in this case, $5.

Without the tax, the equilibrium price would be P1, which would be paid by consumers
and received by producers. The tax pushes the demand curve downward by $5, and the
amount producers get is decreased to P2. Consumers, on the other hand, must pay Pc,
which is precisely what they would pay without the tax at P1. As a result, the burden on
consumers is equal to Pc minus P1. While the producer's burden is P1 – P2 = $5.
This is due to the fact that supply is entirely inelastic—the Red Sox cannot adjust supply
in response to price fluctuations. As a result, they absorb the full tax through lower ticket
costs.
8. A market is described by the following supply and demand curves:
Qs = 2P
QD = 300 – P

a. Solve for the equilibrium price and quantity.

- The equilibrium price as follows:
We have Qs = 2P and QD = 300 – P
=> 2P = 300 – P  2P + P = 300
=> P = 300 / 3 =100
So, the equilibrium price is $100
- The equilibrium quantity as follows
We have QD = 300 – P and P = $100
=> QD = 300 – 100 = 200
So the equilibrium quantity is $200.
b. 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 or surplus?
If the price ceiling of $90 is imposed, which is less that the price of $100, then there will
be a price binding

c. 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 or surplus?

d. Instead of a price control, the government levies a tax on producers of $30. As a

result, the new supply curve is:
Qs= 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?