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dises increases from $8 to $10 if your income is $12,000 b Caleulate your income elasticity of demand as your income increases from S1 the price is $16 (2) (30 points) Suppose that the demand supply for rice is as follows: The equilibrium price is P and the equilibrium quantity is QF in free market. (1) What area can represent the consumer surplus and producer surplus? (2) If government want to control the ric e price level at Po what area can represent the consumer surplus and producer surplus in this case? (3) What kind of policies can fulfill this target? Give some specific example. What is the governments surplus in this case. Draw another graph and color this area. 3 Graph (20 points) . Use Demand and supply diagram and draw graphs to explain why the burden of a tax falls more heavily on the side of the market that is less elastic.

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The consumers and producers surplus are maximum in a free market which is unregulated by the government. But the government intervention to regulate the price in the form of price ceiling and price floor changes the equilibrium condition of the market and causc a substantial changc in the consumers surplus and producers surplus 1. In the given figure the market is in equilibrium at C with the equilibrium price PE and cquilibrium quantity QE. The arca below the demand curve and above the price line is the consumers surplus. The area above the supply curve and below the price line is producers surplus. Before the price fixing by the government there are only two arcas,(two triangles) namcly A and D. The arca A is the arca of consumers surplus and the area D is the area of producers surplus 2. If the government introduces a price control above the equilibrium price the consumers surplus decrease and the producers surplus increase. The producers surplus extended from the area D to D A, and the consumers surplus decrease from the area A to B. D+A is the producers surplus and B is the consumers surplus after the price fixation by the government 3. The price control mcasures likc price cciling and price floor are often adopted by the government to regulate a market which is subjected to wide fluctuations in price which sometimes harm producers and sometimes the consumers. The price ceiling and price floor is adopted in order to minimize the harm and maximize the benefit by preventing unwanted fluctuation in price level Under price ceiling, the government fixes a maximum price above or below the market equilibrium price where the producers are not allowed to sell their products at a price higher than the legally fixed pricc. The government resorted to price ceiling during times of price hike and to prevent the over exploitation on consumers A price cciling above the cquilibrium price transfcrs a part of the consumers surplus to the producers while a price ceiling below the equilibrium price transfers a part of producers surplus to the consumers. A price ceiling above the equilibrium price cause excess supply and shortage of demand and a price ceiling below the equilibrium price cause shortage of supply and excess demand. But a price floor is a minimum price above or below the market equilibrium price where no sales are permitted below the legally fixed price. This is implementedduring times of falling price to ensure higher and more stable income to the producers. The price floor is a supporting measure to the producers whereas a price ceiling is a supporting measure to the consumers. A price floor above the equilibrium price transfers a part of the consumers surplus to the producers while a price floor below the equilibrium price transfers a part of producers surplus to the consumers. A price floor above the equilibrium price cause excess supply and shortage of demand whereas a price floor below the cqiibrium price cause excess demand and shortage of supply. The price control by the government at PG may be a price ceiling or a price floor. The government may give subsidy to the producers when the legally fixed price is below the equilibrium price and the government gives subsidy to the consumers if the legally fixed price is above the equilibrium price. Thus the government surplus is the difference between the subsidy allowed and the tax collected from the market. PS Price control PG PE PR After the price control the government impose a tax equal to the shaded area (Green area Blue area, PR PG PS PQ) out of which the green portion goes to the consumers in the form of tax and the remaining blue portion is left with the government in the form of revenueBefore analyzing the effects of tax on demand and supply we have to consider the tax incident. A market is constituted by producers and buyers. A tax incident is the burden of paying a tax by producers/buyers. The tax burden will be more on the consumers if the demand is inelastic compared to the supply Demand is inelastic Price Pi 01 0 Demand and supply If demand is inelastic greater proportion of tax is shifted to the consumers in the form of high price. TI is the tax incident which is greater on consumers than producers. The producers simply add the tax burden to the price because the quantity demand will not reduce considerably due to price increase.Inelastic supply Price P1T 01 Demand and supply If the supply is inelastic less tax burden will be shifted to the consumers. Because the producers cannot adjust the supply according to variation in price. Here T I is the tax incidence and less portion of it is shared by the consumers and larger portion is shared by the producers. If both demand and supply are inelastic the tax burden will be equally shared by both suppliers and consumers.Demand and supply TI is the tax which is equally share by both the producers and Consume rS.

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