Question

1. In the market for tea, quantity demanded is given Q = 5 – P/2 and quantity supplied is given by Q = P/2, where Q represents tonnes of tea per year. Suppose that the government provides a subsidy of $2 per ton of tea. After the introduction of the subsidy, the equilibrium price and quantity will be

2. Suppose that weekly demand for wool is given by P = 900 – Q, and supply is given by P = 2Q, where Q represents tonnes of wool. To support wool farmers, the government decides to impose a price floor of $400 per tonne. If the government agrees to buy any excess supply, it will have to spend _____ to buy _____ tonnes of wool.

Answer 1

Question 1

Demand equation is as follows -

Q = 5 - P/2

or,

Q = 5 - 0.5P

Supply equation is as follows -

Q = P/2

or,

Q = 0.5P

Now, government provides a subsidy of $2 per ton of tea.

New supply curve is as follows -

Q = 0.5(P + 2)

Q = 0.5P + 1

At equilibrium after subsidy,

Demand = New supply

5 - 0.5P = 0.5P + 1

0.5P + 0.5P = 5 - 1

1P = 4

P = 4

Q = 5 - 0.5P

Q = 5 - (0.5 * 4)

Q = 5 - 2

Q = 3

Thus,

The equilibrium price is $4 per ton.

The equilibrium quantity is 3 tons.

Question 2

Demand equation is as follows -

P = 900 - Q

Supply equation is as follows -

P = 2Q

Before imposition of price floor, equilibrium is attained at,

Demand = Supply

900 - Q = 2Q

3Q = 900

Q = 900/3 = 300

P = 2Q = 2 * 300 = 600

Thus, before imposition of price floor,

The equilibrium price was $600 per ton and the equilibrium quantity is 300 tonnes of wool.

Now, the government has imposed a price floor of $400 per tonne.

A price floor can only be binding when it is fixed at level above the equilibrium price.

The equilibrium price is $600 per ton.

So, if price floor is imposed at $400 per ton then it would not be binding.

Without binding price floor, equilibrium will prevail in the market and there will be no surplus.

Thus, in such case,

If government agrees to buy any excess supply, it will have to spend $0 to buy 0 tonnes of wool.