Question

Suppose there is a market and its competitive equilibrium.

Demand P= 100-QD

Supply P = 20 + QS/3. The government introduces the a subsidy of s = $4 per unit of good sold and bought.

(a) Draw the graph for the demand and supply before subsidy, carefully determining all intercepts and relevant intersection points.

(b) What is the equilibrium price and quantity before the subsidy and after the subsidy? (in the subsidy case, what price the buyers pay and what price the sellers receive?)

(c) Looking at the prices buyers pay and sellers receive after the subsidy compared to the no subsidy case, do buyers or sellers receive more of the subsidy? How much of the $4/unit subsidy is received by the buyers and how much by the sellers? (d) Calculate the price elasticities of demand and supply at the equilibrium before the subsidy. Confirm that the elasticities are inversely proportional to the shares of the subsidy each side (buyers and sellers) receive?

(e) What is the consumer surplus CS and producer surplus PS before and after the subsidy? What is the cost to the government of this subsidy program? What is the DWL (deadweight loss) that comes with the subsidy policy?

(f) Suppose the government is trying to determine the amount of subsidy (they think they can do better than s=$4), to maximize the equilibrium quantity transacted (bought and sold) in the market, yet it has a budget of $1500 to spend on the subsidy provision. What is the maximum quantity the government subsidy can induce, and what is the amount of subsidy per unit to achieve this?

Answer 1