Question 1: Analytical Reasoning Using a Supply and Demand Model (Total: 20 Marks)
Answer all parts of this question. The question involves a series of statements that require you to use the analytical tools and models you have developed to assess. For each statement, you must provide arguments in support or arguments refuting the statement. You must use the appropriate theory supported with the appropriate model to support your arguments. Answers that are not supported with theory will receive a mark of zero. An example is provided to illustrate the approach to answering each of the questions.
EXAMPLE:
Statement:
Demand curves have a positive slope because of the law of demand.
Illustrative Solution:
The statement is incorrect. The law of demand states that as prices increase, quantity demanded decreases, and when prices decrease, quantity demanded increases. In the supply and demand model, the law of demand is represented by movement along the demand curve. Therefore, demand curves have a negative slope as illustrated in the diagram. Moving from price P₁ to the lower price P₂ results in an increase in quantity demanded from Q₁ to Q₂.
End of Example Questions:
1. Evaluate the statement: A positive production externality necessarily results in an allocation in which too much output is consumed relative to the socially efficient output.
{3 marks}
2. Evaluate the statement: Rent control policies are often used to help low-income households afford suitable housing. Rent control policies necessarily improve the welfare for consumers compared to an equilibrium allocation with no rent control.
{3 marks}
3. Evaluate the following situation: Suppose that consumer preferences are such that pizza and a pint of beer are complements. If the consumption tax placed on alcohol increases the price of a pint of beer, then the price of a pizza would increase.
{3 marks}
4. Hastings Caves in Southern Tasmania are renowned for their stalactites and stalagmites. The warden of the caves offers a tour every day at 2 PM. The caves can be shown to only 5 people without disturbing their fragile formations. However, more than five people want to see the caves on the same day. The table lists the people who wanted to see the caves on a particular day. The table reports their arrival time and their reservation price for taking the tour.
{5 marks total}
| Name | Time | Reservation Price ($) |
|---|---|---|
| Herman | 1:48 | 8 |
| Jon | 1:50 | 14 |
| Kate | 1:53 | 11 |
| Jack | 1:56 | 15 |
| Penny | 1:57 | 9 |
| Fran | 1:59 | 40 |
| Faith | 2:00 | 25 |
Consider two possible mechanisms that the warden can implement to restrict entry to the caves to 5 people:
a) The warden operates on a first-come-first-served basis.
b) The warden asks for volunteers to postpone their tour by offering increasing amounts of cash compensation until only five people still wish to see the caves that day (similar to an auction). The warden gives each volunteer the same compensation.
Which policy should the warden implement if the goal is to maximise economic efficiency?
5. Use a supply and demand analysis to predict what will happen to the equilibrium price and quantity of wine if:
- Wine is discovered to increase certain cancers AND
- Excellent weather has increased the number and quality of grapes used to make wine.
You must provide clearly labelled supply and demand diagrams. You must also provide well-written economic arguments supporting your diagrams.
{3 marks}
6. You are currently building a house in a local neighbourhood. The construction of the house emits noise pollution. Assume existing laws are such that you are not allowed to work on your house after 6:00 PM unless you get permission from the community association in which your house is being built. The relevant total costs and benefits of continuing to build after 6:00 PM or shutting down production at 6:00 PM are shown in the table:
| Construction After 6:00 PM | Construction Stops at 6:00 PM | |
|---|---|---|
| Surplus from your home | $6,220 | $6,000 |
| Surplus for the community | $750 | $1,000 |
Suppose you are currently negotiating with the community association. Is there a deal in which you are allowed to continue construction after 6:00 PM? If so, provide the details of a contract allowing you to build after 6:00 PM. If a deal cannot be reached, explain why.
{3 marks}
Question 2: Application of Supply and Demand in Agricultural Markets (Total: 35 Marks)
Use the Excel sheet called Demand_and_Supply.xlsx which contains supply and demand data for Tasmanian-produced hops.
- Use Excel to plot supply and demand. Illustrate the equilibrium price and quantity in the market. Be sure to report the equilibrium price and quantity. Label all elements of the diagram.
{5 marks} - Compute consumer and producer surplus. Illustrate these on the diagram created in part a).
{4 marks} - The first policy the government proposes is to impose a price floor equal to $8.
a) Compute the quantity supplied and the quantity demanded at this price.
{3 marks}
b) What is the effect of this policy on consumer surplus and producer surplus? Illustrate your solution and analyze who benefits and who loses from this policy.
{6 marks}
c) Is there any deadweight loss associated with this policy? If so, compute the deadweight loss and illustrate it.
{4 marks} - The second policy is a deficiency payment program with a support price of $8.
a) Compute the quantity supplied and quantity demanded. Compute the total deficiency payments made to farmers.
{3 marks}
b) What effect does this program have on consumer and producer surplus compared to part b (no intervention)? Is there deadweight loss? Compute it.
{4 marks} - Based on your analysis, which policy should the government implement? Justify your answer with reference to your previous analysis.
{6 marks}