Question

Use the accompanying graph to answer these questions.

a. Suppose demand is D and supply is S0. If a price ceiling of \(6 is imposed, what are the resulting shortage and full economic price?

b. Suppose demand is D and supply is S0. If a price floor of \)12 is imposed, what is the resulting surplus? What is the cost to the government of purchasing any and all unsold units?

c. Suppose demand is D and supply is S0 so that the equilibrium price is \(10. If an excise tax of \)6 is imposed on this product, what happens to the equilibrium price paid by consumers? The price received by producers? The number of units sold?

d. Calculate the level of consumer and producer surplus when demand and supply are given by D and S0 respectively.

e. Suppose demand is D and supply is S0. Would a price ceiling of $2 benefit any consumers? Explain.

Short answer

1. The economy will face a shortage of 3 units and the full economic price is $6.
2. The surplus is 2 units; the cost of government is $18.
3. The equilibrium price rises to $12. The price received by the producer is $6 and the quantity sold is 1 unit.
4. The consumer surplus is $4 and the producer surplus is $8.
5. The consumer will benefit from $2 as they will receive the full consumer and producer surplus combined.

Step-by-step solution

Term Descriptions: 

Price ceiling: In economic terms, the price ceiling indicates the action taken by the government to set a maximum price to which the producers can change the consumers. Price ceiling causes a shortage of products as they are not willing to sell products at a low price.

Price floor: It signifies the action taken by the government to set a minimum price of a commodity to which the consumers cannot pay less. Such, a floor causes a surplus of commodities, as the consumer is not willing to pay more.

Excise Tax: Excise taxes are imposed on the commodities sold by the producers. In such a case, the consumer pays more and the producers receive less than the price charged.

Condition after imposition of price ceiling of $6: 

a.

The equilibrium price is$10 at supply curve S0 and demand curve D and the price ceiling would result in the full economic price to reduce to $6. Such would in turn result in the shortage of products by (4-1) =3 units

Condition after imposition of the price floor of $12:

b.

Imposition of the price floor to $12 will result in a surplus to be (2.5- 1)= 1.5 units. It would be 2 units as a whole. The consumers will now buy less at a higher price and the cost of government on buying that surplus is 1.5 x 12 = $18.

Condition after imposition of excise tax of $6:

c.

Imposition of tax will shift the supply curve to the left side from S0 to S1 as the producers had to pay a tax to the government. The equilibrium price now increases to $12. Thus, the consumer now pays $12 for the commodity. However, the price received by the producer is $6 as the government will take an extra $6 as the taxable amount.

Consumer and Producer Surplus: 

d.

The consumer surplus is = 0.5 x 4 x 2 = $4.

The producer surplus is =0.5 x 8 x 2 = $8.

Condition after imposition of price ceiling of $2:

e.

The consumers will gain profit if the producers produce commodities at a price of as the consumers would receive the full surplus combining both producer and consumer surplus of $12.