Supply and Demand- a Case Study Milk Price

The market supply and demand curve above shows the milk price support problem. In order to solve the milk surpluses in the market, the government should take the steps to increase the market demand to the milk products by exploring overseas markets. For instance, the government should export the milk surpluses abroad. This would cut the cost of storage for milk products and encourages the local dairy farmers continue in dairy business. b. The small dairy farmers would prefer the proposal 4 because it benefits them the most through the buyout program.

This program encourages small dairy farmers to switch from dairy business to another business. The rewards from government can be used as capital to start a new business. c. For consumers, they would prefer the proposal 2. Since the consumers are also the taxpayers, the dairy price support program is very costing to taxpayers. By eliminating the price support program, the consumers can enjoy the lower price of milk and the taxes to purchase unsold milk products can used to support other domestics goods that would be more benefits the consumers. d.

The member of Congress who is concern about the welfare of community will look with favor on the proposal 2. Since they investigated that the market for milk is a competitive market. Without the government intervention, the market equilibrium price for milk is set by the market demand and supply. For the benefits of consumers and taxpayers, they would enjoy a lower milk price than price floor. The problem of the farmers can be solved by increase the demand for dairy products, such as exports the milk surpluses abroad and promote the local brand of milk products to consumers. Question 2 a. When YED = 2,

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Hence, the Transit Authority’s revenue increases as the fare rises. iii. From the estimation, the demand for subway rides is inelastic in short run. The estimation might be unreliable because of the data gathered is only first month after the fare rises. After a longer period, the riders may choose not to use subway and find another way of transportation which is more economical to them. The switch of riders to substitute way of transportation means the quantity demanded for subway decreases. So, when the fare rises, the quantity demanded declines gradually, the price elasticity of demand would be higher and more elastic. . As a clever entrepreneur, it is important to measure how much the quantity demanded of a good responds to changes in consumer’s income. During the prosperity periods, the consumer’s income is higher, they would demand for normal goods and less demand for inferior goods. In periods of depression, the consumer’s income decreases leads to an increase of quantity demanded for inferior goods because their purchasing power is low. If the entrepreneur understands that inferior goods have negative income elasticity (Mankiw, 2007), he would probably switch his business to sell inferior goods.

For example, a used-car seller who might sell branded luxury cars during prosperity periods. However, during depression periods, he might switch to sell low-cost cars in order to sustain his business. In conclusion, the statement is valid. Question 3 a. Diminishing returns to a single factor are observable in all production processes at some level of inputs. The ‘law of diminishing marginal productivity’ is defined as the marginal product of an input is the additional output generated by employing one more unit of the input, all other inputs held fixed.

The extra output, or returns, to the single input diminish because all other inputs are held fixed. One of the factors is capital. For example, as the stock of capital rises, the extra output produced from an additional of capital falls (Mankiw, 2007). Returns to scale are different from the returns to a single factor. Returns to scale are proportional increases in all inputs. While each factor in production process generates diminishing returns, the output may more than double, less than double, or exactly double when all the inputs are doubled.

The distinction again is that with returns to scale, all inputs are increased in the same proportion and no input is held fixed. b. In filling a vacant position, we should be concerned with the marginal product of the last worker hired because the marginal product measures the effect on output, or total product, of hiring another worker. It helps us to determine the revenue generated by hiring another worker and compared it to the cost of hiring another worker. This comparison shows that whether the hiring would help to increase the production.

The point at which the average product begins to decline is the point where average product is equal to marginal product. Although adding more workers results in a further decline in average product, total product continues to increase, so it may still be advantageous to hire another worker. When average product declines, the marginal product of the last worker hired is lower than the average product of previously hired workers. c. The isoquant identifies all the combinations of the two inputs which can produce the same level of output. The curvature of the isoquant is measured by the slope of the isoquant at any given point.

The slope of the isoquant measures the rate at which the two inputs can be exchanged and still keep output constant, and this rate is called the marginal rate of technical substitution. Along the typical “bowed-in” or convex isoquant, the marginal rate of technical substitution diminishes as you move down along the isoquant. SECTION B Question 4 a. To find the equilibrium price and quantity, Qd=Qs 100-5P=5P 10P=100 P=10 When P = 10, Q=5P Q=510 Q=5 ? Equilibrium price is $10, equilibrium quantity is 50 units Price of Negext, $ Market Equilibrium Quantity of Negext, Units 50 0 10 Supply Demand 20

Consumer Surplus Producer Surplus Graph 2 The Negext Market Supply and Demand Consumer Surplus=12 ? $10 ? 50 =$ 250 Producer Surplus=12? $10 ? 50 =$ 250 Total Surplus=Consumer Surplus+Producer Surplus Total Surplus=$250+$250 =$ 500 ? The consumer surplus is $250, the producer surplus is $250 and total surplus is $500. b. When 50 units of Negext are produced, Total Cost of Pollution=50 ? 4 ? $1 =$ 200 The sellers would impose $4 for each units of Negext, so the price for Negext is $14. Total Surplus=$ 500-$200 =$ 300 ? The total surplus after taking into account the cost of pollution, it reduces to $ 300. . We can use total surplus to measure the welfare of buyers and sellers in Negext market. If the society banning Negext, no demand from buyers, Negext will run out of business, the society is not in economic well- being. Both buyers and sellers do not enjoy any welfare from banning. When the total surplus is zero, the total market welfare is zero as well. d. Under the government restriction, the market only can produce 25 units of Negext. (100 units of pollution ? 4 units of pollution are emitted each Negext is produced= 25 units of Negext can be produced) Qs=25 units 00-5 P=25 P=$ 15 ? The new market equilibrium when the quantity 25 units and price is $ 15. Since the minimum cost to produce one unit of Negext is $5 (assuming the cost of production per Negext is $1 and cost of pollution is $4), so the supply of Negext decreases to zero when the price falls below $5. Graph 3 shows the Negext market after the restriction. This restriction limits the production to 25units and the price rises to $15. The consumer surplus decreases to $62. 50, producer surplus is $312. 50, and pollution cost is $100. The total surplus falls $275.

In short, this policy is not recommended because it reduces the total market welfare. Graph 3 The Negext Market Supply and Demand after the government restriction. Price of Negext, $ New Market Equilibrium Quantity of Negext, Units 0 Supply Demand 20 Producer Surplus 15 Consumer Surplus 25 5 Consumer Surplus=12? $5? 25 =$ 62. 50 Producer Surplus=12? ($10+$15)? 25 =$312. 50 Total Cost of Pollution=25 units Negext? 4 units pollution ? $1 =$ 100 Total Surplus=$ 62. 50+$312. 50-$100 =$275 e. The consumers and producers should bear the $2 tax respectively. Inverse Demand : P=18-15Q

Inverse Supply :P=-2+15Q NEW Qd=90-5P NEW Qs=-10+5P Qd=Qs 90-5P=-10+5P P=10 Q=90-5(10) Q=40 units Refer to Graph 4, the market is in equilibrium when price is $10 and quantity, 40 units. However, the actual price paid by the consumers is $12 and the producers receiving price of $8. The tax revenue is $160. The consumer surplus is $160, producer surplus is $160, and total pollution cost is $160. The total surplus increases to $320. So, this policy is highly recommended because the increases of total market welfare that benefits all the society members.

Graph 4 The Neget Market after government imposes tax. Price of Negext, $ Quantity of Negext, Units 40 0 10 Supply Demand 20 12 8 Tax Revenue=$4? 40 =$160 Consumer Surplus=12? $8? 40 =$160 Producer Surplus=12? $8? 40 =$160 Total Cost of Pollution=40? 4? $1 =$100 Total Surplus=$160+$160+$160-$160 =$320 f. When the cost of pollution is higher than $1, the total surplus decreases. The price paid by the consumer increases, the consumer surplus decreases. Then, it would affect the society well-being, especially the welfare of consumer is violated. This leads the consumers banning Negext.

Moreover, if the production of Negext emit such high pollution to environment, the society should ban Negext for the safety and health of society. REFERENCES Smith, 2007. Chapter 6 answers (Online) Available From : http://www. coloradocollege. edu/Dept/EC/Faculty/Smith/EC2070102/chap_06answers. htm (Accessed : 16 July 2011) Wmich. Edu. 2010. Assignments In Class (Online) Available From : http://homepages. wmich. edu/~u5nwaogu/In%20Class%20Assignments/Inclass_3. pdf (Accessed : 16 July 2011) Mankiw, N. Gregory. (2007). Principles of Economics, 4th Edition. USA: Thomson South – Western. pp97-99, 559-562

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