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Practice Question Set 4 Solutions

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20 views1 page

Practice Question Set 4 Solutions

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f20230523
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Q1.

Suppose the government forced all egg producers to sell their products at a “fair price” that
was half the current, free-market price. There will be excess demand at this fair price. What happens
to the consumers’ surplus- increases, decreases, or can’t say? Can’t say

Q2. Anuj is lucky enough to get a rent-controlled apartment for Rs. 3000 per month near Sainikpuri.
The market rent on such an apartment is Rs. 30,000 per month. Anuj himself values the apartment at
Rs. 20,000 per month, and he’d be quite happy with a regular, Rs. 20,000 per month Sainikpuri
apartment. If he stays in the apartment, how much consumer surplus does he enjoy? If he illegally
subleases his apartment to Sakthi on the black market for Rs. 25,000 per month and instead rents a
Rs. 20,000 apartment, is he better off or worse off than if he obeyed the law? Rs. 17,000; better
off by Rs. 05,000.

Q3. What is the consumers surplus for a good with perfectly inelastic demand and a finite price?
Show it graphically. infinite

Q4. Suppose the market demand function is given as Q (P) = 150 - 2P if the price is between 0 to
75, 0 otherwise. Also assume the supply function to be Q (P) = P - 30 if the price is above 30, 0
otherwise.
a. Calculate the consumers’ surplus, producers’ surplus, and social welfare. CS= 225, PS=450,
SW=675
b. Suppose the govt put a tax Rs. 5 per unit to the producers, how does it impact consumers’
surplus, producers’ surplus, tax revenue, social welfare, and deadweight loss. CS= 177.76,
PS=355.64, Tax Revenue=133.33, SW=666.75, DL=8.25.
c. Suppose the govt give a subsidy of Rs. 5 per unit to the producers, how does it impact consumers’
surplus, producers’ surplus, subsidy expenditure, social welfare, and deadweight loss. CS= 277.81,
PS=555.44, Tax Revenue=-166.65, SW=666.60, DL=8.4.
d. Suppose the govt put a price cap (max price) of Rs. 50. How does it impact consumers’ surplus,
producers’ surplus, subsidy expenditure, social welfare, and deadweight loss. CS= 400, PS=200,
SW=600, DL=75.
e. Compare the subsidy policy and the price cap policy. In terms of social welfare, subsidy policy
is better. However the consumers appear to gain more in the price cap policy but the govt can use its
redistributive power alongwith subsidy scheme to make consumers’ better off if it wants.

Q5. Here we have defined efficiency as maximisation of the social welfare. Does efficiency implies
Pareto efficiency? Does Pareto efficiency implies efficiency? Explain govt resdistributive power
(taxes and subsidies) in this context.
Yes, efficiency implies Pareto efficiency. In efficiency, we are already maximising the sum hence its
not possible to increase CS or PS without decreasing other.
Pareto efficiency does not imply efficiency. For example consider a price cap policy which fixes the
price below the market price. Its not efficient as we have deadweight loss here. It maybe Pareto
efficient- there does not exist any other price where all the consumers and producers enjoy higher
surplus!
However notice the government can use its redistributive power to distribute the ‘cliamed
deadweight loss’ in such a maner that everyone is happy as there is net surplus as we move to
market equilibrium.

Q6. We have seen that competitive market maximises social welfare where social welfare is
consumers’ surplus + producers’ surplus + govt revenue (if any). Here what happens if we replace
producers’ surplus with profit, will the competitive market still maximise the social welfare?
Yes, adding a constant term does no effect optimisation.

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