Econ 300: Midterm 4
Due: Friday, Nov. 2, 2012
1. Suppose the price of a good is kept below the equilibrium price through government mandated price controls.
a. Demonstrate the differences in consumer and producer surplus between this price-controlled situation versus allowing prices to clear the market at the equilibrium.
b. Will the consumers always be better off paying the lower (price-controlled) price as opposed to the higher equilibrium price? Demonstrate your answer.
2. Why would sellers NEVER knowingly price their products where the demand facing them is “inelastic”?
3. You are the manufacturer of chocolate candy bars. You decide that a 10% price increase in your product is warranted due to increased costs and have two possible ways to implement it:
a. You can increase the price of your candy bars by 10% without changing anything else about them.
b. You can leave the nominal price per candy bar unchanged but shrink the size of your bars to make the price per ounce increase by 10%.
If your marketing department tells you that at your current sales level, the price elasticity for the underlying demand for chocolate is -1.2,
a. If you decide to go with strategy (a), you would increase the price of your 10 oz. Bar by 10%. If you were selling 10,000 bars per day before the price increase, how many would you expect to sell after the price increase?
b. If you decide to go with strategy (b), you would decrease the size of your candy bar from 10 oz to 9.0909 oz. while leaving the nominal price per bar unchanged. If you were selling 10,000 bars per day before you downsized the bars, how many of these smaller candy bars will you expect to sell?
(Note: stores sometimes choose strategy (b). An example is Wal-Mart ice cream. Can you cite other examples?)
4. In class we demonstrated how an “ad valorum” sales tax affects consumers and sellers (demanders and suppliers). We also noted that the effect of the tax on buyers and sellers was the same regardless of whether the tax was nominally imposed on buys or sellers and that such a tax would result in “dead weight” losses. Instead of an ad valorum tax, suppose the government imposes a “lump sum” tax. Demonstrate your answers to the following questions.
a. Will there be “dead weight” losses associated with a lump sum tax that raises the same revenue as the ad-valorum tax?
b. Will the effect of the tax on buyers and sellers be the same regardless of who the lump sum tax is nominally levied against?
- Is there a maximum lump sum tax that the government can levy on a buyer? If so, is that the same as the maximum amount it can levy on a seller?
Something to think about (not graded): The following is a “strategy game” that is different from those discussed in class. See if you can come up with the answer.
There are five rational pirates, A, B, C, D and E. They find 100 gold coins. They must decide how to distribute them. The Pirates have a strict order of seniority: A is superior to B, who is superior to C, who is superior to D, who is superior to E.
The Pirate world's rules of distribution are thus: that the most senior pirate should propose a distribution of coins. The pirates should then vote on whether to accept this distribution; the proposer is able to vote, and has the casting vote in the event of a tie. If the proposed allocation is approved by vote, it happens. If not, the proposer is thrown overboard and dies, and the next most senior pirate makes a new proposal to begin the system again.
Pirates base their decisions on three factors. First of all, each pirate wants to survive. Secondly, each pirate wants to maximize the amount of gold coins they receive. Thirdly, each pirate would prefer to throw another overboard, if all other results would otherwise be equal.
Since A goes first, what should his/her proposal be?