EC 201 Student Name:
Cal Poly Pomona Class Meeting Time:
Spring, 2007
Dr. Bresnock
Homework Assignment 3 (Answers) (25 points)
1. Suppose the total demand for wheat and the total supply of wheat per month in the Kansas City grain market are as follows:
Thousands ofbushels demanded / Price per
bushel / Thousands of
bushels supplied / Surplus (+) or
shortage (-)
85 / $4.60 / 72 / -13
80 / 4.80 / 73 / -7
75 / 5.00 / 75 / 0
70 / 5.20 / 77 / 7
65 / 5.40 / 79 / 14
60 / 5.60 / 81 / 21
(a) What will be the market or equilibrium price? What is the market or equilibrium quantity? Using the surplus-shortage column, explain why your answers are correct.
PE = $5.00
QE = QD = QS = 75
At prices below $5.00 QD > QS è Shortage
At prices above $5.00 QS > QD è Surplus
(b) Using the above data, graph the demand for wheat and the supply of wheat. Be sure to label the axes of your graph correctly. Label equilibrium price “PE” and equilibrium quantity “QE”.
P S
è Surplus (c)
PFloor = $5.40
PE = $5.00 è Shortage (d)
PCeiling = $4.80
D
0 QE = 75 Q
(c) Why will $4.60 not be the equilibrium price in the market? Why not $5.60? “Surpluses drive prices up; shortages drive them down.” Do you agree?
At P = $4.60 QD > QS è P increases
P = $5.60 QS > QD è P decreases
Surpluses drive prices down, shortages drive prices up.
Quote states exactly the opposite.
(d) Now suppose that the government establishes a ceiling price of, say, $4.80 for wheat. Explain carefully the effects of this ceiling price. Demonstrate your answer graphically (use the graph in part B). What might prompt government to establish a ceiling price?
See graph in (b) At P = $4.80. A shortage of 7 units will result. Lines form, orders are placed, and under-the-counting tipping may occur. Government may establish an policy to make the product more affordable.
(e) Assume now that the government establishes a supported price of, say, $5.40 for wheat. Explain carefully the effects of this supported price. Demonstrate your answer graphically (use the graph in part B). What might prompt government to establish this price support?
See graph in (b). At P = $5.40 a surplus of 14 units will result. Dumping abroad, storage, or destruction of units will occur. Government may establish a policy to make the income of suppliers keep pace with the prevailing cost of living.
(f) “Legally fixed prices strip the price mechanism of its rationing function.” Explain this statement in terms of your answers to 1(d) and 1(e).
Price controls prevent prices from rising (d) or falling (e) to their natural equilibrium level.
2. Other thing being equal, what effect will each of the following have upon the demand, quantity demanded, supply, quantity supplied, equilibrium quantity and equilibrium price of, product B? Draw simple graphs as part of your explanation and clearly label the axes and functions.
(a) The price of product C, a good substitute for B, goes down.
Market for Product B
PB
ç S DB decreases →
è Temporary excess supply (AB) →
PE A B Decrease PE
Decrease QE
PE′ C Decrease in QS from B to C
ç DB
DB′
0 QE’ QE Q
Decrease in “Demand” from DB to DB′
Decrease in “Quantity Supplied” from B to C
(b) Consumers anticipate declining prices and falling income.
TODAY
P
S D decreases →
ç è Temporary excess supply (AB) →
PE A B Decrease PE
Decrease QE
PE′ C Decrease in QS from B to C
ç D
D′
0 QE′ QE Q
Expected decline in future price of good è decrease today’s demand for the good.
Expected fall in future income è increases today’s savings, reduces today’s demandè decrease today’s demand for the good.
Together, these events decrease the demand for goods in the economy.
Decrease in “Demand” from D to D′
Decrease in “Quantity Supplied” from B to C
(c) An increase in the prices of resources required in the production of B.
P S′
S
ç
PE′ C S decreases →
è Temporary excess demand (AB) → PE A B Increase PE
ç Decrease QE
D Decrease in QD from B to C
0 QE′ QE Q
Decrease in “Supply” from S to S′
Decrease in “Quantity Demanded” from B to C
(d) The levying of a special sales tax upon B.
P S′
S
ç
PE′ C S decreases →
è Temporary excess demand (AB) → PE A B Increase PE
ç Decrease QE
D Decrease in QD from B to C
0 QE′ QE Q
Decrease in “Supply” from S to S′
Decrease in “Quantity Demanded” from B to C
(e) Demand for B decreases and supply for B decreases.
P S′ S P S′ S P S′ S
PE
PE PE′
PE′ PE
D D D
D′ D′ D′
0 QE′ QE Q 0 QE′ QE Q 0 QE′ QE Q
Change in price depends on magnitude, or size, of shifts in S and D, Q always falls to QE′.
Note that in examples (a) through (d) only one of the functions changed and as a result there is an unambiguous result in terms of the effect on the equilibrium price and quantity. If both supply and demand change, there will be indeterminate results in terms of either equilibrium price or quantity. Indeterminate means that either price or quantity may increase, decrease or stay the same depending on the size of the shifts of the supply and demand.
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