Question

1. Draw and explain a market with a binding price floor. Does this create a shortage or a surplus in the market? Why? a. Draw and explain a market with a binding price ceiling. Does this create a shortage or a surplus in the market? Why? b. Draw and explain how a per unit tax on shoes impacts the market. Does the tax increase or decrease TS? Why? c. Suppose a $2 per unit tax is placed on packs of cigarettes. Without the tax, suppose the price per pack is $3 (this is the equilibrium price) and quantity is 1000 packs. Suppose further that the demand for cigarettes is more inelastic than the supply of cigarettes. Lastly, suppose the tax is placed on the suppliers of cigarettes. d. Draw a graph showing the original equilibrium price and quantity, the tax, and the price paid by the consumer and the price received by the seller. e. Who bears the burden of the tax? Does the seller ultimately pay most of the tax since they write the check to the government? Why or why not?

Answer 1

a) Price Floor: When government fixes the price of a product at a level higher than equilibrium price, it is called support price. As a result, the supply becomes in excess of demand. Support price is the minimum guaranteed price at which producers can sell their output to the government if so desired. The main consequence of support price is that consumers have to pay a higher price for the good. On the other hand, the income of the producers goes up. The aim of support price is to insulate the farmers from fluctuations in their income which are caused by price variations in the free market. Surplus occurs under price floor.

b) Price Ceiling: When government fixed price of a product at a level lower than the equilibrium price, the price is called control price or price control by the government. This is done to control the interest of the consumers. The implication or consequence of price control are as follows:

a) Rationing: It is a system of distributing essential goods in limited quantities at control prices. It is reported when due to a shortage, a certain good is not available at reasonable price. Government establishes Public Distribution System as a tool to help the consumers.

b) Black market: Another result of price control can be an emergence of a black market in which the commodity is sold at a price higher than the government's fixed price. The reason is that on the one side, sellers are not ready to sell at a lower price fixed by the government and on the other side, some consumers are ready to offer a higher price to satisfy their demand for a commodity. A black market is that market situation in which goods are sold at prices higher than the price fixed by the government by law.

C) Tax on shoes; Tax shifts supply curve leftwards as shown below.

Total surplus falls due to tax. T.S falls due to occurrence of dead-weight loss.