Friday, October 29th, 2010

Supply, Demand, and Price Controls Study Guide

Use the following supply and demand schedules for bicycles to answer the questions below.

Price                            Quantity Demanded                              Quantity Supplied

300                                          60                                                        30

400                                          55                                                        40

500                                          50                                                        50

600                                          45                                                        60

700                                          40                                                        70

800                                          35                                                        80

In response to lobbying by the Bicycle Riders Association, Congress places a price ceiling of $700 on bicycles.  What effect will this have on the market for bicycles?  Why?

No effect because above the equilibrium price.

In response to lobbying by the Bicycle Riders Association, Congress places a price ceiling of $400 on bicycles.  Use the information provided above to plot the supply and demand curves for bicycles.  Impose the price ceiling.  What is the result of a price ceiling of $400 on bicycles?

$400 price and a shortage.  QD = 55 and QS = 40.  Shortage of 15 bicycles.

Does a price ceiling of $400 on bicycles make all bicycle buyers better off?  Why or why not?

It makes some bicycle buyers better off if they are able to buy a bike at the cheaper price; however, some bicyclists won’t be able to buy a bike due to the shortage.  These buyers are worse off.

Suppose instead Congress imposes a price floor on bicycles of $700.  Use the information provided above to plot the supply and demand curves for bicycles.  Impose the $700 price floor.  What is the result of the $700 price floor?

$700 price and surplus.  QD = 40 and QS = 70.  Surplus of 30 bicycles.

What is the impact on the price and quantity in a market if a price ceiling is set above the equilibrium price?  Why?

No impact (non-binding) because market prices and quantities will still prevail.

What is the impact on the price and quantity in a market if a price ceiling is set below the equilibrium price?

The price will fall, and a shortage will exist.

What are some of the problems created by a binding price ceiling?

Shortages, sellers won’t want to produce as much because the price is lower, and buyers won’t be able to buy as much as they would like at the lower price.

What is the impact on the price and quantity in a market if a price floor is set below the equilibrium price?  Why?

No impact (non-binding) because market prices and quantities will still prevail.

What is the impact on the price and quantity in a market if a price floor is set above the equilibrium price?

Surpluses.  Sellers won’t be able to sell as much as they would like at the higher prices, and buyers won’t be able to buy as much at the higher prices.

True/False.

If the equilibrium price of gasoline is $1.00 per gallon and the government places a price ceiling on gasoline of $1.50 per gallon, the result will be a shortage of gasoline.   False

A price ceiling set below the equilibrium price causes a surplus.  False

A price floor set above the equilibrium price is a binding constraint.  True

The minimum wage helps all teenagers because they receive higher wages than they would otherwise.  False

A price floor in a market always creates a surplus in that market.  False

Multiple Choice Questions.

1.)    For a price ceiling to be a binding constraint on the market, the government must set it

  1. Above the equilibrium price.
  2. Below the equilibrium price.
  3. Precisely at the equilibrium price.
  4. At any price because all price ceilings are binding constraints.

Answer: B

2.)    A binding price ceiling creates

  1. A shortage.
  2. A surplus.
  3. An equilibrium.
  4. A shortage or a surplus depending on whether the price ceiling is set above or below the equilibrium price.

Answer: A

3.)    Suppose the equilibrium price for apartments is $500 per month and the government imposes rent controls of $250.  Which of the following is unlikely to occur as a result of the rent controls?

  1. There will be a shortage of housing.
  2. Landlords may discriminate among apartment renters.
  3. Landlords may be offered bribes to rent apartments.
  4. The quality of apartments will improve.
  5. There may be long lines of buyers waiting for apartments.

Answer: D

4.)    A price floor

  1. Sets a legal maximum on the price at which a good can be sold.
  2. Sets a legal minimum on the price at which a good can be sold.
  3. Always determines the price at which a good must be sold.
  4. Is not a binding constraint if it is set above the equilibrium price.

Answer: B

5.)    Which side of the market is more likely to lobby government for a price floor?

  1. Neither buyers or sellers desire a price floor.
  2. Both buyers and sellers desire a price floor.
  3. The sellers.
  4. The buyers.

Answer: C

6.)    Which of the following is an example of a price floor?

  1. Rent controls
  2. Restricting gasoline prices to $1.00 per gallon when the equilibrium price is $1.50 per gallon.
  3. The minimum wage
  4. All of the above are price floors.

Answer: C

          Price

                      $1.20

                       $1.00                                                                                                                                         $.80                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            900 1000 1100              Quantity of gasoline

                              (millions of gallons per week)

7.)    The graph above shows the supply and demand curves for gasoline.  Which of the following will occur if the government establishes a price ceiling of $1.20 per gallon?

  1. A shortage of 900 million gallons
  2. A shortage of 200 million gallons
  3. A shortage of 100 million gallons
  4. A surplus of 100 million gallons
  5. Neither a surplus nor a shortage

Answer: E

8.)    Which of the following is true of a price floor?

  1. The intention of the government in creating the price floor is to assist the producers of the good.
  2. To have an impact in the market for the good, the price floor should be set below the existing market price of the good.
  3. An effective price floor will increase the quantity demanded of the good.
  4. The price floor would tend to create a shortage of the good in the market.
  5. The creation of the price floor would not change the quantity supplied of the good if the supply curve were upward-sloping to the right.

Answer: A

9.)    If the minimum wage for teenagers increased to a rate higher than their market equilibrium wage, what would be the effect on their wage and employment?

  1. Wage would increase, there would be no effect on employment.
  2. Wage would increase, and employment would increase.
  3. Wage would increase, and employment would decrease.
  4. Wage would decrease, and employment would increase.
  5. Wage would decrease, and employment would decrease.

Answer: C

10.)                        The market equilibrium price of home heating oil is $1.50 per gallon.  If a price ceiling of $1.00 per gallon is imposed, which of the following will occur in the market for home heating oil?

  1. Quantity supplied will increase.
  2. Quantity demanded will increase.
  3. Quantity supplied will decrease.
  4. Quantity demanded will decrease.

 

  1. II only
  2. I and II only
  3. I and IV only
  4. III and IV only
  5. II and III only

Answer: E

11.)                        An effective price floor introduced in the market for rice will result in

  1. A decrease in the price of rice and an increase in the quantity of rice sold.
  2. A decrease in the price of rice and a decrease in the quantity of rice sold.
  3. A decrease in the price of rice and an excess demand for rice.
  4. An increase in the price of rice and an excess supply of rice.
  5. An increase in the price of rice and an excess demand for rice.

Answer: D

12.)                        Suppose than an effective minimum wage is imposed in a certain labor market above the equilibrium wage.  If labor supply in that market subsequently increases, which of the following will occur?

  1. Unemployment in that market will increase.
  2. Quantity of labor supplied will decrease.
  3. Quantity of labor demanded will increase.
  4. Market demand will increase.
  5. The market wage will increase.

Answer: A

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