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1. Suppose the market for widgets can be described by the following equations:

Demand: P = 10 – Q Supply: P = Q – 4

where P is the price in dollars per unit and Q is the quantity in thousands of units. Then:

a. What is the equilibrium price and quantity?

b. Suppose the government imposes a tax of $1 per unit to reduce widget consumption and raise government revenues. What will the new equilibrium quantity be? What price will the buyer pay? What amount per unit will the seller receive?

c. Suppose the government has a change of heart about the importance of widgets to the happiness of the American public. The tax is removed and a subsidy of $1 per unit granted to widget producers. What will the equilibrium quantity be? What price will the buyer pay? What amount per unit (including the subsidy) will the seller receive? What will be the total cost to the government?

2. Japanese rice producers have extremely high production costs, due in part to the high opportunity cost of land and to their inability to take advantage of economies of large-scale production. Analyze two policies intended to maintain Japanese rice production: (1) a per-pound subsidy to farmers for each pound of rice produced, or (2) a per-pound tariff on imported rice. Illustrate with supply-and-demand diagrams the equilibrium price and quantity, domestic rice production, government revenue or deficit, and deadweight loss from each policy. Which policy is the Japanese government likely to prefer? Which policy are Japanese farmers likely to prefer?

3. In 1983, the Reagan Administration introduced a new agricultural program called the Payment-in-Kind Program. To see how the program worked, let’s consider the wheat market.

a. Suppose the demand function is QD = 28 – 2P and the supply function is QS = 4 + 4P, where P is the price of wheat in dollars per bushel, and Q is the quantity in billions of bushels. Find the free-market equilibrium price and quantity.

a. Now suppose the government wants to lower the supply of wheat by 25 percent from the free-market equilibrium by paying farmers to withdraw land from production. However, the payment is made in wheat rather than in dollars – hence the name of the program. The wheat comes from vast government reserves accumulated from previous price support programs. The amount of wheat paid is equal to the amount that could have been harvested on the land withdrawn from production. Farmers are free to sell this wheat on the market. How much is now produced by farmers? How much is indirectly supplied to the market by the government? What is the new market price? How much do farmers gain? Do consumers gain or lose?

b. Had the government not given the wheat back to the farmers, it would have stored or destroyed it. Do taxpayers gain from the program? What potential problems does the program create?

4. The United States currently imports all of its coffee. The annual demand for coffee by U.S. consumers is given by the demand curve Q = 250 – 10P, where Q is quantity (in millions of pounds) and P is the market price per pound of coffee. World producers can harvest and ship coffee to U.S. distributors at a constant marginal (= average) cost of $8 per pound. U.S. distributors can in turn distribute coffee for a constant $2 per pound. The U.S. coffee market is competitive. Congress is considering a tariff on coffee imports of $2 per pound.

a. If there is no tariff, how much do consumers pay for a pound of coffee? What is the quantity demanded?

b. If the tariff is imposed, how much will consumers pay for a pound of coffee? What is the quantity demanded?

c. Calculate the lost consumer surplus.

d. Calculate the tax revenue collected by the government.

e. Does the tariff result in a net gain or a net loss to society as a whole?

5. The domestic supply and demand curves for hula beans are as follows:

Supply: P = 50 + Q Demand: P = 200 – 2Q

where P is the price in cents per pound and Q is the quantity in millions of pounds. The U.S. is a small producer in the world hula bean market, where the current price (which will not be affected by anything we do) is 60 cents per pound.

Congress is considering a tariff of 40 cents per pound. Find the domestic price of hula beans that will result if the tariff is imposed. Also compute the dollar gain or loss to domestic consumers, domestic producers, and government revenue from the tariff.

Chapter 10 Problems:

1. The following table shows the demand curve facing a monopolist who produces at a constant marginal cost of $10:

a. Calculate the firm’s marginal revenue curve.

b. What are the firm’s profit-maximizing output and price? What is its profit?

c. What would the equilibrium price and quantity be in a competitive industry?

d. What would the social gain be if this monopolist were forced to produce and price at the competitive equilibrium? Who would gain and lose as a result?

2. Suppose a profit-maximizing monopolist is producing 800 units of output and is charging a price of $40 per unit.

a. If the elasticity of demand for the product is –2, find the marginal cost of the last unit produced.

b. What is the firm’s percentage markup of price over marginal cost?

c. Suppose that the average cost of the last unit produced is $15 and the firm’s fixed cost is $2000. Find the firm’s profit.

3. A certain town in the Midwest obtains all of its electricity from one company, Northstar Electric. Although the company is a monopoly, it is owned by the citizens of the town, all of whom split the profits equally at the end of each year. The CEO of the company claims that because all of the profits will be given back to the citizens, it makes economic sense to charge a monopoly price for electricity. True or false? Explain.

4. A monopolist faces the following demand curve:

Q = 144/P2

where Q is the quantity demanded and P is price. Its average variable cost is

AVC = Q1/2

and its fixed cost is 5.

a. What are its profit-maximizing price and quantity? What is the resulting profit?

b. Suppose the government regulates the price to be no greater than $4 per unit. How much will the monopolist produce? What will its profit be?

c. Suppose the government wants to set a ceiling price that induces the monopolist to produce the largest possible output. What price will accomplish this goal?

Chapter 11 Problems:

1. Suppose that BMW can produce any quantity of cars at a constant marginal cost equal to $20,000 and a fixed cost of $10 billion. You are asked to advise the CEO as to what prices and quantities BMW should set for sales in Europe and in the United States. The demand for BMWs in each market is given by:

QE = 4,000,000 – 100 PE and QU = 1,000,000 – 20PU

where the subscript E denotes Europe, the subscript U denotes the United States. Assume that BMW can restrict U.S. sales to authorized BMW dealers only.

Correction : Prices and costs are in dollars, not thousands of dollars as your book may indicate.

a. What quantity of BMWs should the firm sell in each market, and what should the price be in each market? What should the total profit be?

b. If BMW were forced to charge the same price in each market, what would be the quantity sold in each market, the equilibrium price, and the company’s profit?

2. A monopolist is deciding how to allocate output between two geographically separated markets (East Coast and Midwest). Demand and marginal revenue for the two markets are:

P1 = 15 – Q1 MR1 = 15 – 2Q1

P2 = 25 – 2Q2 MR2 = 25 – 4Q2

The monopolist’s total cost is C = 5 + 3(Q1 + Q2 ). What are price, output, profits, marginal revenues, and deadweight loss (i) if the monopolist can price discriminate? (ii) if the law prohibits charging different prices in the two regions?