Question

you are the mexican president and people are protestind due to the extremely high price for tortillas. To avoid ending up impeached you set a $1 subsidy to producers of the tortillas. your economics consult reports supply as P=2+2Q and the demand is Q= 10-2P

- do you trust the report why?

- what is the dead weight loss?

- why such a loss is created by your policy?

- will you add a price ceiling to $2.5 on top of current policy (subsidy) to alleviate the situation? why?

Answer 1

Answer:

Part-1) Yes the reports are trust worthy. As the equillibrium price in the market is 4.4 and only 1.2 quantity are demanded and supplied at this price. This is very bad situation of economy for whic people are protesting.

(Note: Equilibrium Price: 10-2P = 0.5P-1 or, 2.5P=11 or, P=4.4).

Part-2) Due to $1 subsidy new supply function becomes P=1+2Q

Now new equillibrium Price: 10-2P = 0.5P-0.5 or, 2.5P=10.5 or, P = 4.2

New equillibrium Price = 4.2

New equillibrium quantity = 1.6

Dead weight loss = area of triangle shaded in graph

To calculate the area shaded in graph, following data needs to be calculate.

1. Price at new equillibrium quantity using pre-subsidy supply function: P(1)=2+ (2*1.6) or, P(1)=5.2

2. Pre subsidy equillibrium price P(2) = 4.4

3. Post subsidy equillibrium price P(3)= 4.2

4. Pre subsidy equillibrium quantity Q(2)= 1.2

5. Post subsidy equillibrium quantity Q(1) = 1.6

Dead weight loss = area of triangle shaded in graph:

= 1/2[ { Q(1)-Q(2) } * { P(2) - P(1) } ] + 1/2[ { Q(1)-Q(2) } * { P(3) - P(2) } ]

= 1/2 [ (1.6-1.2) * (4.4-4.2) ] + 1/2 [ (1.6-1.2) * (5.2-4.4) ] = 0.2

Dead weight loss = 0.2 (Answer)

Part-3) Deadweight loss due to a subsidy is created because due to this amount of consumer and producer surplus reduces. This shows the inefficiency of economy. As due to subsidy more than the economically best quantity is produced and supplied in market.

Part-4) If we add a price ceiling of $2.5 over this policy.

Dead weight loss becomes 0.9 which is 450% higher than dead weight loss due to producers subsidy that is 0.2. This show that if price ceiling will be imposed, economy will get further ineffient. At this price ceiling only 0.75 quantity will be available for supply by producers while demand will be of 5 quantity. There will be huge difference between demand and supply and thus protest will rise.