Question

1. The market for cigars in New York City is perfectly competitive, with the weekly demand and supply curves given by: QD = 110 – 10P QS = 5 + 5P A. Using the equations, solve for equilibrium price and quantity in this market.

B. Next, graph the demand and supply curves in the grid below. Be sure to indicate equilibrium price and quantity. Check that equilibrium price and quantity in the graph match your answer to part A (above).

C. A $3 per cigar tax is imposed on sellers in this market. Solve for the new equilibrium by using just the equations and substituting in the actual value of the tax. [Hint: Remember, there are now two prices in the market: PD paid by consumers, and Ps received by sellers. Their relationship is (PD – tax) = PS, where tax = $3.] What is the new price paid by consumers? What is the new price received by sellers? How many cigars will be bought and sold?

D. On your graph, show the effect of the tax on the supply curve, the effective price paid by consumers, and the effective price received by sellers.

E. Who pays more of the tax? What does this tell you about the relative elasticities of the demand and supply curves?

F. What is the deadweight loss associated with the imposition of this tax? Show this on your graph, and provide a numerical value.

G. If the demand curve were less elastic, how would this affect your answer in part E? And in part F? 2.

In the spring of 2003, the international community experienced the outbreak of Severe Acute Respiratory Syndrome (SARS), a contagious and frequently deadly disease that appears to have originated in China. Concern over catching this disease greatly discouraged travel to and within China. Based on an exam question.

A. With the aid of the graph provided, explain the effect of this outbreak on the market for airline travel within China (where, in fact, there are numerous competing airlines).

B. Interested in protecting Chinese airlines from the effects of these changes, in July of that same year the government of China considered imposing a price floor for all airline travel within China. Suppose the government sets the price floor at the pre-SARS equilibrium price. Show in a graph and explain what will happen in this market.

C. If the stated objective of this policy is to ensure that revenues for Chinese airlines (from travel within China) will return to pre-SARS levels, will the policy accomplish its goal? Explain.

D. This proposed policy was criticized by the China Daily News, with one reporter predicting a decline in revenues for suppliers, compared to what they would earn with no price floor. Explain whether this argument is correct.

Answer 1