Chapter 3
Answers to Questions in Chapter 3
Note: No. before indicates a page number
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75Draw a supply and demand diagram with the price of labour (the wage rate) on the vertical axis and the quantity of labour (the number of workers) on the horizontal axis. What will happen to employment if the Industrial Relations Commission raises wages from the equilibrium to some minimum wage above the equilibrium?
The diagram will look like Figure 3.1 in the text. Employment will fall to Qd workers. The supply of workers will rise to Qs. There will thus be unemployment (a surplus of workers) of Qs minus Qd.
76(Box 3.1) 1. How could housing supplied by the public sector be made to rectify some of the problems we have identified above? (What would it do to the supply curve?)
It would shift the supply of rental accommodation to the right, and thereby reduce the free-market rent; or it would reduce the shortage of accommodation in the case where rents are fixed below the equilibrium.
76(Box 3.1) 2. Using supply and demand curves, show the likely effect of rent control on: (a) the supply of private flats; (b) the demand for rent collectors.
(a)The supply of private flats for rent would decrease (a movement down the supply curve); the supply of private flats for sale would increase (a rightward shift of the supply curve), as more were put on the market having been withdrawn from the rental sector.
(b)With lower rents, people would be more likely to pay them promptly, especially as they would be afraid of not finding other accommodation should they be evicted. Thus the demand for rent collectors would decline (shift to the left).
76(Box 3.1) 3. If the government gives poor people rent allowances (i.e. grants), how will this affect the level of rents in an uncontrolled market?
They will increase (the demand for rented accommodation will increase).
76(Box 3.1) 4. The case for and against rent controls depends to a large extent on the long-run elasticity of supply. Do you think it will be relatively elastic or inelastic? Give reasons.
Relatively elastic. Below a certain rent, it will not be worth the owners incurring the costs and time of renting out the accommodation. The solution, therefore, to cheap affordable accommodation is to tackle the supply directly: either by public housing or by subsidising or giving tax relief to the private sector.
77(Box 3.2) 1. What would be the effect on black-market prices of a rise in the official price?
Other things being equal, there would probably be a fall in the black-market price. A rise in the official price would cause an increase in the quantity supplied and a reduction in the quantity demanded and hence less of a shortage. There would therefore be less demand for black-market products.
77(Box 3.2) 2. Will a system of low official prices plus a black market be more equitable or less equitable than a system of free markets?
More equitable if the supplies at official prices were distributed fairly (e.g. by some form of rationing). If, however, supplies were allocated on a first-come, first-served basis, then on official markets there would still be inequity between those who are lucky enough or queue long enough to get the product and those who do not get it. Also, the rich will still be able to get the product on the black market!
77(Box 3.2) 3. Think of some examples where the price of a good or service is kept below the equilibrium (e.g. rent controls). In each case consider the advantages and disadvantages of the policy.
The price of foodstuffs is controlled in many countries. As in the case of rent controls the advantage is that the price of an essential item is kept low, allowing those on low incomes to afford them. The disadvantage is that there is permanent excess demand leading to corruption etc. The best way to ensure adequate supplies and allow the poor to buy essential items is to abolish the price controls and make transfer payments to the poor. Unfortunately this is not a feasible option in low income countries.
78Show the effect of the imposition of an ad valorem tax on the supply curve.
The supply curve would swivel upwards as shown in Diagram 3.1. The higher the price the greater the dollar amount of the tax.
79Demand tends to be more elastic in the long run than in the short run. Assume that a tax is imposed on a good that was previously untaxed. How will the incidence of this tax change over time?
The proportion borne by the consumer will decrease over time, and that carried by the producer will increase (as in Figure 3.5)
79(Box 3.3) 1. If raising the tax rate on cigarettes both raises more revenue and reduces smoking, is there any dilemma?
There may still be a dilemma in terms of the amount by which the tax rate should be raised. To raise the maximum amount of revenue may require only a relatively modest increase in the tax rate. To obtain a large reduction in smoking, however, may require a very large increase in the tax rate. Ultimately, if the tax rate were to be so high as to stop people smoking altogether, there would be no tax revenue at all for the government!
79(Box 3.3) 2. You are a government minister; what arguments might you put forward in favour of maximising the revenue from cigarette taxation?
That it is better than putting the taxes on more socially desirable activities. That there is the beneficial spin-off from reducing a harmful activity. (You would conveniently ignore the option of putting up taxes beyond the point that maximises revenue and thus cutting down even more on smoking.)
79(Box 3.3) 3. You are a doctor; why might you suggest that smoking should be severely restricted? What methods would you advocate?
That the medical arguments concerning damage to health should take precedence over questions of raising revenue. You would probably advocate using whatever method was most effective in reducing smoking. This would probably include a series of measures from large increases in taxes, to banning advertising, to education campaigns against smoking. You might even go so far as to advocate making smoking tobacco illegal. The problem here, of course, would be in policing the law.
81Why don’t farmers benefit from a high income elasticity of demand for convenience foods?
Because most of the increased expenditure goes on value added in the processing, not on the basic food content. Thus it is the food processors who get the benefit, not the farmers.
81(Box 3.4) 1. What does the negative income elasticity for mutton mean? What do economists call goods such as mutton? What implications are there for farmers producing these foods?
That consumption of these foods goes down as incomes rise. They are `inferior goods’.
Farmers as a whole would expect to earn less as time goes past from producing these foods, given that national income rises over time. Thus if the incomes of individual farmers are to be protected, production should be reduced (with some farmers switching to other foodstuffs or away from food production altogether).
81(Box 3.4) 2. Why do you think the price elasticity of demand for chicken or for bacon and ham is lower than for the other meats shown in the table?
The other meats are closer substitutes for each other than for chicken or for bacon and ham.
81(Box 3.4) 2. The price elasticity of demand for all meat is 0.55. Why is this lower than the elasticities for different types of meat?
There are fewer substitutes for all meat.
82(Box 3.5) 1. Can you think of any other (non-farming) examples of the fallacy of composition?
Two examples are:
- People standing to get a better view at a concert. When one person does this, then that person will get a better view. When everyone does it, there is no gain. In fact, there is a net loss, because people would presumably prefer to sit than stand!
- If one person gets a pay increase 5 per cent above the current rate of inflation, he or she will be 5 per cent better off (assuming no change in the rate of inflation). If everyone gets a pay increase 5 per cent above the current rate of inflation, then that will drive the rate of inflation up. People will not be 5 per cent better off.
82(Box 3.5) 2. Would the above arguments apply in the case of foodstuffs that can be imported as well as being produced at home?
In the case of a foodstuff that can be imported, the demand curve for the domestically produced foodstuff would be more elastic (given that the imports are a substitute). Thus a good domestic harvest may only depress the price slightly, with consumers merely switching from the imported to home-grown food. Thus producers would gain from a good harvest (their incomes would rise if elasticity was greater than one).
If, however, the good harvest were worldwide, so that total world supply of the product increased, then the problem would still occur if the overall demand (for home-grown plus imported food) were inelastic.
83(Box 3.6) Would you expect the demand for corn from the storehouses to be price elastic or inelastic? What implications does your answer have for the price Joseph could have charged if he had wanted to maximise revenue for Pharaoh?
Price inelastic, given that there was no other source of supply. This means that Joseph could have charged a very high price. The specific price that would have maximised revenue would have been that which was high enough to make the income effect large enough to cause price elasticity of demand to rise to unity.
84(Box 3.7) Some economists have argued that the best way to dispose of the wool stockpile is to burn it. How could such a policy be justified?
If the world demand for wool was price inelastic the sales from the stockpile will cause total revenue accruing to all producers to fall. More generally it is argued that the wool price will not recover while the stockpile exists.
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