Chapter 2

Review Questions

1. What is the difference between “scarcity” and “shortage”?

A shortage occurs when, at a given price, quantity demanded exceeds quantity supplied.
Scarcity implies that not everyone can consume as much of a good as he wants. A good can
be scarce without a shortage occurring if the price of the good is set at the market
equilibrium.

2. What would the supply curve look like for a good that is not scarce? Assuming the good is
useful, what would its demand curve look like? Explain why a positive price for a commodity
implies that it is scarce.
The supply curve would be a horizontal line where the price equals zero. The demand curve
would be a typical demand curve. If the price is greater than zero, then the market system is
acting to allocate resources; not everyone can have as much as they want.

3. Give two examples of actions taken by the administration of your college or university
whose effect is to prevent specific markets from reaching equilibrium. What evidence of
excess supply or excess demand can you cite in these examples?
Some examples: Parking places for the president of the university creating a shortage of
parking spaces. Putting a cap on the number of students allowed to do a course creating
excess demand.

4. What is the difference between “a reduction in supply” and “a reduction in the quantity
supplied”?
The former implies a shift in the supply curve; the latter a movement along the supply curve.

5. Identify each of the following as (1) a change in demand or (2) a change in the quantity
demanded.

a. Grape consumption falls because of a consumer boycott.

 b. Grape consumption falls because of a tax on grape producers.

c. Grape consumption rises because of a good harvest.

d. Grape consumption rises because of a change in tastes.

a. Shift in demand
b. Change in quantity demanded (shift in supply)
c. Change in the quantity demanded (shift in supply)
d. Shift in demand

6. When there is excess supply, why is any single seller able to sell all she wants to by offering
only a small reduction below the current market price?
Because consumers prefer to pay a lower price.

7. Give an example of a market in which the allocative function of price is not very important.
The allocative function of price is not important with vertical, or nearly vertical, supply
curves, e.g., land.

8. Suppose you are a government official and need to collect revenue by taxing a product. For
political reasons, you want the burden of the tax to fall mostly on consumers, not firms (who
have been substantial contributors to your campaign fund). What should you look for when
picking a product to tax?
For the tax burden to fall mostly on consumers rather than producers (buyers rather than
sellers), you want to find a product (or products) for which the quantity supplied is very
responsive to price but quantity demanded is less responsive to price. Addictive goods like
cigarettes and alcohol may fit this description.

9. Which would a rational poor person be more likely to accept and why?

a. A €50,000 Mercedes (immediate resale value = €30,000)

b. €35,000 cash
If a poor person were given €50,000 in cash, it is unlikely he would spend it on a Mercedes, since
he probably has other, more pressing wants. Since the gift Mercedes would fetch less than the
cash gift, most poor persons would choose the cash.
Problems

1. Assume that tea and lemons are complements and that coffee and tea are substitutes.

a. How, if at all, will the imposition of an effective ceiling price on tea affect the price of

lemons? Explain.

b. How, if at all, will the imposition of an effective ceiling price on tea affect the price of

coffee? Explain.

a) The imposition of the ceiling price on tea causes a reduction in the quantity of tea bought,
from Q1 to Q2 (left panel). The result is a leftward shift in the demand for lemons, resulting in a

reduction in both price and quantity (right panel).

Price Price
S S

P1l
P1t
P2l
P2t D1

D D2

Q2 t Q 1 t Tea Q2 l Q1 l Lemons

b) The ceiling price for tea lowers the quantity people are able to buy from Q1t to Q2t. There is

excess demand for tea at the ceiling price P2t, and some of this excess demand spills over to

substitute products such as coffee. The result is that the equilibrium price of coffee rises. (Note:
This result may seem inconsistent with the claim that a fall in the price of a good's substitute
reduces the demand for that good. But this claim refers to a fall in the equilibrium price of the
good, not a price reduction caused by a ceiling. Because of the quantity reduction caused by the

ceiling, tea buyers would be willing to pay P3t for tea. So the price ceiling actually raises the

opportunity cost of additional units of tea.)

 Pcoffee
P tea
St
Sc
P3t
Pc
P1t 2
c
P
Pt 1
2
D2
D D
1
t
Q Qt Qtea Qc Q c Q
coffee
2 1 1 2

2. The market for DVDs has supply and demand curves given by P = 2Qs and P = 42  Qd,

respectively.

a. How many units will be traded at a price of €35? At a price of €14? Which participants will

be dissatisfied at these prices?

b. What quantity of DVDs at what price will be sold in equilibrium?

c. What is the total revenue from DVD sales?

a) At price €35 supply is 17.5 and demand is 7. So, 7 DVDs will be traded in the market and sellers
are dissatisfied. At price €14 supply is 7 and demand is 28. So, 7 DVDs will be traded and buyers are
dissatisfied.

b) In equilibrium, demand equals supply, meaning . This implies Q = 14 and P = €28.

The supply and demand curves, shown in the diagram, intersect at P=€28, Q=14

Price S
42

35

28

21

14

7
D
Quantity
7 14 21 28 35 42
c) Total revenue is (28)(14) = 392.

3. Hardware and software for computers are complements. Discuss the effects on the equilibrium

price and quantity

a. In the software market, when the price of computer hardware falls.

b. In the hardware market, when the price of computer software rises.

a-b) A reduction in the price of hardware would raise demand for software and thus cause
equilibrium price and quantity of software to rise. On the other hand, a rise in the price of
software would reduce demand for hardware and thus cause the equilibrium price and quantity
of hardware to fall.

4. Suppose a newly released study shows that battery-powered toys harm a child’s development

and recommends that parents adjust their purchasing behaviour accordingly. Use diagrams to

show the effect on price and quantity in each of the following markets:

a. The market for battery-powered toys.

b. The market for D batteries.

c. The market for yo-yos (which do not require batteries).

a) Both price and quantity drop.

P(toys)

P1

P2
D1

D2
Q(toys)
Q2 Q1
b) Both quantity and price drop.
 P(battery)

P1

P2
D1

D2
Q(battery)
Q2 Q1

c) Both price and quantity go up.

P(yo-yos)

P2

P1
D2

D1
Q(yo-yos)
Q1 Q2

5. Using diagrams show what changes in price and quantity would be expected in the following

markets under the scenarios given:

a. Crude oil: As petroleum reserves decrease, it becomes more difficult to find and recover

crude oil.

b. Air travel: Worries about air safety cause travellers to shy away from air travel.

c. Rail travel: Worries about air safety cause travellers to shy away from air travel.

d. Hotel rooms in Hawaii: Worries about air safety cause travellers to shy away from air

travel.

e. Milk: A genetically engineered hormone enables large milk producers to cut production

costs.
a) The price goes up, the quantity goes down.

P(oil)
S2

S1
P2

P1

D
Q(oil)
Q2 Q1

b) The price and the quantity go down.

P(air)

P1

P2
D1

D2
Q(air)
Q2 Q1

c) The price and the quantity go up.

P(rail)

P2

P1
D2

D1
Q(rail)
Q1 Q2

d) The price and the quantity go down.

 P(hotel)

P1

P2
D1

D2
Q(hotel)
Q2 Q1

e) The price goes down, the quantity goes up.

P(milk)
S1

S2
P1

P2

D
Q(milk)
Q1 Q2

6. For each scenario in Problem 5, state whether the effect is a change in demand or just a

change in quantity demanded.

a) In quantity demanded.
b) In demand.
c) In demand.
d) In demand.
e) In quantity demanded.

7. Suppose demand for seats at football games is P = 1900  (1/50)Q and supply is fixed at Q =

90,000 seats.
 a. Find the equilibrium price and quantity of seats for a football game (using algebra and a

graph).

b. Suppose the government prohibits tickets scalping (selling tickets above their face value),

and the face value of tickets is €50 (this policy places a price ceiling at €50). How many

consumers will be dissatisfied (how large is excess demand)?

c. Suppose the next game is a major rivalry, and so demand jumps to P = 2100  (1/50)Q.

How many consumers will be dissatisfied for the big game?

d. How do the distortions of this price ceiling differ from the more typical case of upward-

sloping supply?

a) Supply is 90,000 irrespective of price. So, the equilibrium quantity is Q = 90,000 seats and the
equilibrium price is P = 1900 – (1/50)(90,000) = 1900 – 1800 = €100.

b) At a price ceiling of P = €50, quantity demanded is found by solving 50 = 1900 – (1/50)Q for Q =
92,500 seats. Since the stadium only holds Q = 90,000 seats, there will be 92,500 – 90,000 = 2,500
dissatisfied fans who want to buy a ticket at P = €50 but cannot find one available.

c) Quantity demanded for the higher demand is found by solving 50 = 2100 – (1/50)Q for Q=
102,500 seats. Now there will be 102,500 – 90,000 = 12,500 dissatisfied fans who want to buy a
ticket at P = €50 but cannot find one available. The excess demand is 12,500 – 2,500 = 10,000 seats
more than for the not so big game.

d) Normally a price ceiling both raises quantity demanded and lowers quantity supplied. Here, only
the first effect is present because the stadium capacity is fixed.

S
Price (€)
350
300 D’
D

100
50

0 80 90 92.5 102.5 105

Quantity of seats per game (000)
8. The demand for apartments is P = 1200  Q while the supply is P = Q units. The government

imposes rent control at P = €300/month. Suppose demand grows in the market to P = 1400 

Q.

a. How is excess demand affected by the growth in demand for apartments?

b. At what price would the government have to set the rent control to keep excess demand

at the same level as prior to the growth in demand?

a) Under the original demand curve, quantity demanded was Q = 900 units and quantity supplied Q
= 300 units, so excess demand was 900 – 300 = 600 units. With the larger demand, quantity
demanded becomes Q = 1100 units, so excess demand becomes 1100 – 300 = 800 units. Excess
demand has grown by 800 – 600 = 200 units.
b) Quantity demanded is Q = 1400 – P; quantity supplied is Q = P. Subtracting quantity supplied
form quantity demanded gives excess demand of 1400 – 2P units. Set excess demand equal to
the original level of 600 and solve 600 = 1400 – 2P for the required price floor of P = €400. If the
government accommodates the increase in demand by raising the rent control form €300 to
€400, the degree of excess demand will be unchanged.

Price (€)
600

S D D’

400

300

0 300 400 900 1000 1100 1400

Quantity (units/month)
9. Suppose demand is P = 600  Q and supply is P = Q in the wheat market, where Q is tons of

wheat per year. The EU sets a price support at P = €500/ton and purchases any excess supply

at this price. In response, as a long-run adjustment, farmers switch their crops from corn to

wheat, expanding supply to P = (1/2)Q.

a. How does excess supply with the larger supply compare to excess supply prior to the

farmers switching crops?

b. How much more does the EU have to spend to buy up the excess supply?

a) With a price support of P = €500/tonne and the original supply of P = Q, quantity supplied must
be Q = P = 500 tonnes. Meanwhile, quantity demanded is Q = 100 tonnes, so excess supply is 500
– 100 = 400 tonnes. With the expanded supply of P = (1/2)Q, quantity supplied grows to Q = 2P =
1000 tonnes. Quantity demanded is still Q = 100 tonnes, so excess supply grows to 1000 – 100 =
900 tonnes.

b) The extra 900 – 400 = 500 tons the EU has to buy of excess supply costs €500/ton, so the added
expenditure is 500(500) = €250,000.

Price (€)
600
S
500

S’

0 100 500 1000

Quantity (tons/yr)

10. How would the equilibrium price and quantity change in the market depicted below if the

marginal cost of every producer were to increase by €2/kilogram? (Hint: Recall the vertical

interpretation of the supply curve discussed in Chapter 1.)

The supply curve becomes P = 2 + 2Q and the demand remains P = 8 – 2Q. By setting the two
equations equal to each other and solving for Q we have Q = 1.5 kilograms. Substituting 1.5 into the
demand equation results in a price of €5.

Appendix Problems

1. The government, fearful that a titanium shortage could jeopardize national security, imposes a

tax of €2/g on the retail price of this rare metal. It collects the tax from titanium sellers. The

original supply and demand schedules for titanium are as shown in the diagram. Show, in the

same diagram, how the short-run equilibrium price and quantity of titanium will be affected by

the tax. Label all important points clearly.

The supply curve after the tax is shown as S' in the diagram. The new equilibrium quantity will
fall to 2. The equilibrium price paid by the buyers is now €4/g. The price received by the sellers
is now €2/g.
2. In the market for titanium described in Problem 1 (with no tax), suppose that a price floor of
€4/g results in sales of only 2 tonnes/yr (with no tax). Describe a transaction that will make
some buyers and sellers better off without harming others.
The supply curve tells us that at a quantity of 2 tonnes/yr, suppliers will be willing to supply
additional titanium at a price of €2/g. At that same quantity, buyers are willing to pay €4/g.
Suppose a supplier sells one gram to a new buyer at a price of €3. This will make the supplier
better off by €1. The buyer will also be better off by €1.

3. Suppose the titanium market in Problem 1, with a tax of €2/g, experiences growth in the
demand for titanium because of new-found medical uses. The new demand curve is P = 8  Q.
Find the change in government tax revenue due to the heightened demand for titanium.
With the tax of T = €2/g on sellers, the supply curve shifts up by the amount of the tax from P =
Q to P = 2 + Q. The intersection of the tax-ridden supply curve and the new demand curve is
found by solving 8 – Q = 2 + Q for Q = 3 tonnes. Inserting the quantity into the demand curve
yields a price buyers pay of P = 8 – 3 = €5/g and hence a price sellers receive of P = 5 – 2 = €3/g.
There are 1,000,000 grams per tonne. The government collects revenue of TQ = 2(3) = €6
million. Prior to the increase in demand, the government collected the tax on only 2 tonnes, so
its total revenue collected was €4 million. Thus, government revenue has grown by 6 – 4 = €2
million due to the expansion in demand for titanium. See the graph below

Price of Titanium (€)

8 S’ S

0
3 8
Quantity of Titanium (tonnes/yr)

4. Suppose instead the titanium market in Problem 2, with no tax but a price floor at €4/g, suffers a
reduction in supply because of dwindling titanium reserves. The new supply curve is P = 2 + Q.
How does excess supply change due to the reduction in supply? Is the price floor still binding
(does it cause price to rise from its equilibrium level)?
 At a price floor of P = €4/g, quantity supplied would be Q = 4 tonnes. Quantity demanded would
be Q = 2 tonnes giving an excess supply of 2 tonnes. Demand is still Q = 2 tonnes after the
change in supply. Supply satisfies 4 = 2 + Q giving Q = 2 tonnes. Thus, the reduction in supply
raises the equilibrium price to the level of the price floor, so the price floor is no longer binding.

Price of Titanium (€)

S’
6
S
4

0 2 4 6

Quantity of Titanium (tonnes/yr)

5. The supply and demand curves in the market for DVDs are given by P = 2Q and P = 42 – W.

Suppose the government levies a tax of €9 on each DVD sold, collected from sellers.

a. What quantity of DVDs will be sold in equilibrium?

b. What price do buyers pay?

c. How much do buyers now spend in total?

d. How much money goes to the government?

e. Show the above results graphically.

a) The effect of the tax is to shift the supply curve upwards by €9 as shown in the diagram on the
next page. The quantity sold falls to 11 units.
b) The new market price is €31, of which the seller gets to keep only €22.
c) Buyers now spend 11(31)=€341.
d) The government collects 11(9) = €99.
 e) s'
Price S
42

35

28

21

14

7
D
Quantity
7 14 21 28 35 42

6. For the tax described in Problem 5,

a. What fraction of the tax does the seller bear?

b. What fraction of the tax does the buyer bear?

a-b) The seller's share is the fall in price received by the seller divided by the total tax:
ts = 6/9=2/3. The buyer's share is the increase in price divided by the total tax: tb = 3/9=1/3.

7. U.S. President, Ronald Reagan negotiated a “voluntary” import quota on Japanese cars sold in the
United States in the early 1980s. Some of his advisers had recommended that he impose a higher
import tax (tariff) instead. Assuming the tariff was in the form of a constant tax T per Japanese
car sold in the U.S. and that T was chosen to produce the same quantity reduction as the quota,
how will the prices paid for Japanese cars by U.S. consumers compare under the two policies?
In the diagram below, P* and Q* are the original equilibrium price and quantity of Japanese cars
sold in the U. S. If a quota of Q1 is imposed, Japanese car makers will be able to charge P1 for

their cars. To get the same quantity reduction by means of a tax, the after tax supply curve must
intersect the demand curve at Q1. The result is a price to the U. S. buyer of P1, the same as in

the quota case. The difference in the two policies is that in the quota case the price increase
goes to Japanese car makers, while in the tariff case it goes to the U. S. government.
 Price S'
S

P1

P*

P -T
1

D
Quantity
Q1 Q*

8. Many studies on rats and mice have established that charred meat grilled over hot coals causes

cancer. Since the government cannot easily regulate home cooking methods, an alternative

method has been proposed to discourage the consumption of barbecued meat. The proposal is

to place a 100 per cent tax at the retail level on charcoal briquettes. Suppose the daily demand

for charcoal was P = 120  2Q and the supply was P = 30 + Q, where P is in euros per bag and Q is

the number of 20-kg bags of charcoal sold weekly.

a. What is the before- and after-tax price of charcoal?

b. What is the before- and after-tax quantity of charcoal?

c. How is the tax divided among sellers and buyers?

Price S(tax)

120 S

90

60
45
30
D
Quantity
15 30 60

a) Before-tax: 120-2Q=30+Q (in equilibrium) Q=30 bags P=€60

 b) After-tax supply curve: P = 60 + 2Q
Equilibrium: 120 - 2Q = 60 + 2Q
Q = 15 bags
Price, including tax = €90
Price received by seller (net of tax) = €45.

c) Sellers share = 60 – 45 = €15 Buyer’s share = 90 – 60 = €30

9. Supply is P = 4Q, while demand is P = 20, where P is price in euros per unit and Q is units of

output per week.

a. Find the equilibrium price and quantity (using both algebra and a graph).

b. If sellers must pay a tax of T = €4/unit, what happens to the quantity exchanged, the price

buyers pay, and the price sellers receive (net of the tax)?

c. How is the burden of the tax distributed across buyers and sellers and why?

a-c) With the tax on sellers, supply rises by the amount of the tax to P = 4 + 4Q. The equilibrium is
found by solving 20 = 4 + 4Q for Q = 4 units. Buyers pay P = €20 and sellers receive 20 – 4 = €16.
Sellers pay the full tax because demand is perfectly elastic, which means that buyers cannot be
forced to pay any of the tax.

Supply + tax
Supply
Price (€) 28

20 D
16

0 4 5 Quantity (units/wk)

10. Repeat Problem 9, but instead suppose the buyer pays the tax, demand is P = 28  Q, and supply

is P = 20.
a-c) With the tax on buyers, demand falls by the amount of the tax to P = 24 – Q. The equilibrium is
found by solving 20 = 24 – Q for Q = 4 units. Sellers receive P= €20, and buyers pay 20 + 4 = €24.
Buyers pay the full tax because supply is perfectly elastic, which means that sellers cannot be forced
to pay any of the tax.

Problem A2-10
Price (€)

28

24 D

20 S
D’

0 4 8
Quantity (units/wk)