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Chapter 9: Problem 5

About 100 million pounds of jelly beans are consumed in the United States each year, and the price has been about 50 cents per pound. However, jelly bean producers feel that their incomes are too low and have convinced the government that price supports are in order. The government will therefore buy up as many jelly beans as necessary to keep the price at \(\$ 1\) per pound. However, government economists are worried about the impact of this program because they have no estimates of the elasticities of jelly bean demand or supply. a. Could this program cost the government more than \(\$ 50\) million per year? Under what conditions? Could it cost less than \(\$ 50\) million per year? Under what conditions? Illustrate with a diagram. b. Could this program cost consumers (in terms of lost consumer surplus) more than \(\$ 50\) million per year? Under what conditions? Could it cost consumers less than \(\$ 50\) million per year? Under what conditions? Again, use a diagram to illustrate.

Short Answer

Expert verified
Yes, the program could cost the government and consumers more than \(\$ 50\) million per year if the elasticity of demand is inelastic, or less than \(\$ 50\) million if it is elastic. The exact cost depends on the price elasticities of demand and supply. The graphical illustrations would show the price floor and the changes in consumer and producer surplus.

Step by step solution

01

Understand the concept of price supports

Price supports are artificial prices set by the government to ensure that producers receive certain minimum prices. However, when the government sets a price above the equilibrium price (in this case, \(\$ 1\) per pound instead of the equilibrium price of 50 cents per pound), this is referred to as a price floor.
02

Analyze the impact of the price floor on producers and the government

The implementation of the price floor means that the jelly bean producers can now sell their product at a higher price. The amount the government will need to pay will be the difference between the new price (price floor) and the old price, times the quantity. If the quantity demanded decreases significantly due to the increased price, the government's total expenditure could theoretically be less than \(\$ 50\) million. However, if the quantity demanded does not decrease significantly, the outlay could be more than \(\$ 50\) million. This depends on the elasticity of demand.
03

Create a Diagram Illustrating the Price Floor

On a diagram with quantity on the x-axis and price on the y-axis, draw a downward-sloping demand curve and an upward-sloping supply curve that intersect at the equilibrium price of 50 cents. Then draw a horizontal line representing the price floor at \(\$ 1\) per pound. Notice that at this price, the quantity supplied will be higher than the quantity demanded, resulting in a surplus of jelly beans that the government will have to buy to maintain the price.
04

Analyze the impact on consumers

The new price will likely decrease the quantity of jelly beans demanded, leading to a lower consumer surplus as consumers either have to pay a higher price or consume less of the product. This loss in consumer surplus may exceed \(\$ 50\) million if the demand is relatively inelastic, if consumers continue to buy jelly beans despite the price increase. If the demand is elastic, consumers may drastically reduce their consumption, leading to a decrease in consumer surplus of less than \(\$ 50\) million. This will depend on the elasticity of demand.
05

Create a Diagram Illustrating Consumer Surplus

The consumer surplus can be visualized on the same diagram from Step 3. It is the area between the demand curve and the price level, up to the quantity demanded. After the price increase, the consumer surplus area becomes smaller, indicating a decrease in consumer surplus.

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Most popular questions from this chapter

In \(1983,\) the Reagan administration introduced a new agricultural program called the Payment-in-Kind Program. To see how the program worked, let's consider the wheat market: a. Suppose the demand function is \(Q^{D}=28-2 P\) and the supply function is \(Q^{S}=4+4 P\), where \(P\) is the price of wheat in dollars per bushel, and \(Q\) is the quantity in billions of bushels. Find the freemarket equilibrium price and quantity. b. Now suppose the government wants to lower the supply of wheat by 25 percent from the freemarket equilibrium by paying farmers to withdraw land from production. However, the payment is made in wheat rather than in dollarshence the name of the program. The wheat comes from vast government reserves accumulated from previous price support programs. The amount of wheat paid is equal to the amount that could have been harvested on the land withdrawn from production. Farmers are free to sell this wheat on the market. How much is now produced by farmers? How much is indirectly supplied to the market by the government? What is the new market price? How much do farmers gain? Do consumers gain or lose? c. Had the government not given the wheat back to the farmers, it would have stored or destroyed it. Do taxpayers gain from the program? What potential problems does the program create?

You know that if a tax is imposed on a particular product, the burden of the tax is shared by producers and consumers. You also know that the demand for automobiles is characterized by a stock adjustment process. Suppose a special 20 -percent sales tax is suddenly imposed on automobiles. Will the share of the tax paid by consumers rise, fall, or stay the same over time? Explain briefly, Repeat for a 50 -cents-per-gallon gasoline tax.

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Japanese rice producers have extremely high production costs, due in part to the high opportunity cost of land and to their inability to take advantage of economies of large-scale production. Analyze two policies intended to maintain Japanese rice production: (1) a per-pound subsidy to farmers for each pound of rice produced, or (2) a per-pound tariff on imported rice. Illustrate with supply-and-demand diagrams the equilibrium price and quantity, domestic rice production, government revenue or deficit, and deadweight loss from each policy. Which policy is the Japanese government likely to prefer? Which policy are Japanese farmers likely to prefer?

The domestic supply and demand curves for hula beans are as follows: \\[ \begin{aligned} \text {Supply:} & P=50+Q \\ \text {Demand:} & P=200-2 Q \end{aligned} \\] where \(P\) is the price in cents per pound and \(Q\) is the quantity in millions of pounds. The U.S. is a small producer in the world hula bean market, where the current price (which will not be affected by anything we do) is 60 cents per pound. Congress is considering a tariff of 40 cents per pound. Find the domestic price of hula beans that will result if the tariff is imposed. Also compute the dollar gain or loss to domestic consumers, domestic producers, and government revenue from the tariff.
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