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5: Market Efficiency and Market Distortions: Practice Quiz

Terms in this set (17)

The table below presents the average monthly demand and supply of 4' × 8' sheets of plywood from a typical home building supply store. In any month when coastal states such as Florida are threatened by hurricanes, the typical monthly demand for plywood increases by 400 sheets at every price. Imagine Florida passes a "price gouging" law that prevents home building supply stores from raising the price of plywood when hurricanes threaten.

Market for Plywood
Price (dollars) | Initial Quantity of Plywood Demanded (sheets) | Initial Quantity of Plywood Supplied (sheets) | New Quantity of Plywood Demanded (sheets)
$106,600 | 3,800 | 7,000
116,400 | 4,000 | 6,800
126,200 | 4,200 | 6,600
136,000 | 4,400 | 6,400
145,800 | 4,600 | 6,200
155,600 | 4,800 | 6,000
165,400 | 5,000 | 5,800
175,200 | 5,200 | 5,600
185,000 | 5,400 | 5,400
194,800 | 5,600 | 5,200
204,600 | 5,800 | 5,000
214,400 | 6,000 | 4,800

Instructions: Enter your answers as a whole number.

a. When there are no hurricanes threatening Florida, and without the "price gouging" law in place, what are the equilibrium price and quantity in the plywood market?

P = $ __

Q = ____ sheets

b. When hurricanes threaten Florida, and without the "price gouging" law in place, what are the equilibrium price and quantity in the plywood market?

P = $ __

Q = ____ sheets

c. When hurricanes threaten Florida, and with the "price gouging" law in place, what are the market price of plywood, the quantity demanded of plywood, and the quantity supplied of plywood?

P = $ __

Qd = ____ sheets

Qs = ____ sheets

d. If the "price gouging" law goes into effect, the result of the law during hurricane season will be to create a

multiple choice
◉ shortage of 600 sheets of plywood.
◉ shortage of 400 sheets of plywood.
◉ surplus of 400 sheets of plywood.
◉ surplus of 600 sheets of plywood.
Part a:
P = $ 17
Q = 5,200 sheets

Part b:
P = $ 18
Q = 5,400 sheets

Part c:
P = $ 17
Qd = 5,600 sheets
Qs = 5,200 sheets

Part d: shortage of 400 sheets of plywood.

Explanation
a. The initial equilibrium occurs where the initial quantity demanded and the quantity supplied are the same. This occurs where the initial demand curve and supply curve intersect. In this case, the equilibrium price is $17 and the equilibrium quantity is 5,200 sheets of plywood.

b. With no "price gouging" law, the new equilibrium occurs where the new quantity demanded and quantity supplied are the same. Graphically, this occurs where the new demand curve and supply curve intersect. In this case, the equilibrium price is $18 and the equilibrium quantity is 5,400 sheets of plywood.

c. With the "price gouging" law in place, the market will not be able to go to the new equilibrium. The highest the price can go is the price ceiling equal to the original price. Therefore, with the "price gouging" law in place, the market price will be $17. At this price, going to the new demand curve, the quantity demanded will be 5,600 sheets of plywood. However, at this price moving to the supply curve, we find a quantity supplied of only 5,200 sheets of plywood.

d. Because of the "price gouging" law acting as a price ceiling, the quantity demanded remains high at 5,600 sheets of plywood but producers do not have an incentive to increase quantity, and the quantity supplied remains at 5,200 sheets of plywood. Therefore, the quantity demanded exceeds the quantity supplied, resulting in a shortage of 400 sheets of plywood.
The market for packs of AA batteries during a typical week in Tulsa, Oklahoma, is described in the table below.

Market for AA Batteries in a Typical Week
Price (dollars) |Quantity of Batteries Demanded (packs) | Quantity of Batteries Supplied (packs)
$20 | 0 | 150
18 | 10 | 130
16 | 20 | 110
14 | 30 | 90
12 | 40 | 70
10 | 50 | 50
8 | 60 | 30
6 | 70 | 10

Instructions: Enter your answers as a whole number.

a. During a typical week in Tulsa, Oklahoma, what are the equilibrium price and quantity in the market for AA batteries?

P = $ __

Q = __ packs

In weeks when tornadoes threaten Tulsa, Oklahoma, the demand for packs of AA batteries increases as shown in the table below.

Market for AA Batteries with Tornado Threat
Price (dollars) | New Quantity of Batteries Demanded (packs) | New Quantity of Batteries Supplied (packs)
$24 | 0 | 180
22 | 10 | 160
20 | 20 | 140
18 | 30 | 120
16 | 40 | 100
14 | 50 | 80
12 | 60 | 60
10 | 70 | 40
8 | 80 | 20
6 | 90 | 0

b. What are the equilibrium price and quantity of AA batteries in a week with a tornado threat?

P = $ __

Q = __ packs


Suppose that city leaders want to prevent the price of AA batteries from rising when tornadoes threaten Tulsa, Oklahoma. They impose a price ceiling of $10 for packages of AA batteries.

c. This price ceiling of $10 per pack ____ ___ ______ the AA battery market during a typical week.

d. What are quantity demanded and quantity supplied with the price ceiling in effect during the weeks when tornadoes threaten Tulsa?

Qd = __ packs

Qs = __ packs

e. As a result of the price ceiling

multiple choice
◉ quantity supplied exceeds quantity demanded by 30 packs of AA batteries in a week when tornadoes threaten Tulsa, Oklahoma.
◉ quantity supplied equals quantity demanded for packs of AA batteries in a week when tornadoes threaten Tulsa, Oklahoma.
◉ quantity demanded exceeds quantity supplied by 30 packs of AA batteries in a week when tornadoes threaten Tulsa, Oklahoma.
◉ quantity supplied exceeds quantity demanded by 40 packs of AA batteries in a week when tornadoes threaten Tulsa, Oklahoma.
Part a:
P = $ 10
Q = 50 packs

Part b:
P = $ 12
Q = 60 packs

Part c: will not impact

Part d:
Qd = 70 packs
Qs = 40 packs

Part e: quantity demanded exceeds quantity supplied by 30 packs of AA batteries in a week when tornadoes threaten Tulsa, Oklahoma.

Explanation
a. The equilibrium occurs where the quantity demanded and quantity supplied are the same. Graphically, this occurs where the demand curve and supply curve intersect. In this case, the equilibrium price is $10 and the equilibrium quantity is 50 packs of AA batteries.

b. With no price ceiling, the new equilibrium occurs where the new quantity demanded and the new quantity supplied are the same. This occurs where the new demand curve and new supply curve intersect. In this case, the equilibrium price is $12 and the equilibrium quantity is 70 packs of batteries.

c. Even if there is a price ceiling of $10, there will be no impact in the market during a typical week. Because the equilibrium price is $10 and the price ceiling is $10, the market is still allowed to go to equilibrium.

d. With the price ceiling in place, the market will not be able to go to the new equilibrium. The highest the price can go is the "price ceiling" equal to $10. Therefore, with the price ceiling, the market price will be $10. At this price, going to the new demand curve, the quantity demanded will be 70 packs of AA batteries. However, at this price moving to the new supply curve, we find a quantity supplied of only 40 packs of AA batteries.

e. When the price ceiling is in place during weeks when tornadoes threaten, the quantity demanded is 70 packs but the quantity supplied is only 40 packs. Therefore, the quantity demanded exceeds the quantity supplied and there is a shortage in the market of 30 packs of AA batteries.
The U.S. Department of Agriculture guarantees dairy producers that they will receive at least $1.00 per pound for butter they supply to the market. Below is the current monthly demand and supply schedules for wholesale butter (in millions of pounds per month).

Market for Wholesale Butter
Price (dollars per pound) | Quantity of Butter Demanded (millions of pounds) | Quantity of Butter Supplied (millions of pounds)
$0.80 | 116 | 76
0.90 | 114 | 84
1.00 | 112 | 92
1.10 | 110 | 100
1.20 | 108 | 108
1.30 | 106 | 116
1.40 | 104 | 124
1.50 | 102 | 132
1.60 | 100 | 140
1.70 | 98 | 148
1.80 | 96 | 158

Instructions: Round your answer for price to two decimal places. Enter your answers for quantity as a whole number.

a. What are the equilibrium price and quantity in the wholesale butter market?

P = $ ___

Q = ___ million pounds

b. What is the monthly surplus created in the wholesale butter market due to the price support (price floor) program?

multiple choice
◉ 11 million pounds
◉ 22 million pounds
◉ zero
◉ 79 million pounds

Suppose that a decrease in the cost of feeding cows shifts the supply schedule to the right by 30 million pounds at every price.

c. Fill in the new supply schedule given the change in the cost of feeding cows.

Market for Wholesale Butter
Price (dollars per pound) | Quantity of Butter Demanded (millions of pounds) | Initial Quantity of Butter Supplied (millions of pounds) | New Quantity of Butter Supplied (millions of pounds)
$0.80 | 116 | 76 | ?
0.90 | 114 | 84 | ?
1.00 | 112 | 92 | ?
1.10 | 110 | 100 | ?
1.20 | 108 | 108 | ?
1.30 | 106 | 116 | ?
1.40 | 104 | 124 | ?
1.50 | 102 | 132 | ?
1.60 | 100 | 140 | ?
1.70 | 98 | 148 | ?
1.80 | 96 | 158 | ?

d. Given the new supply of butter, what is the monthly surplus of butter created by the price support program?

__ million pounds
Part a:
P = $ 1.20
Q = 108 million pounds

Part b: zero

Part c: Table Answer
Market for Wholesale Butter
Price (dollars per pound) | Quantity of Butter Demanded (millions of pounds) | Initial Quantity of Butter Supplied (millions of pounds) | New Quantity of Butter Supplied (millions of pounds)
$0.80 | 116 | 76 | 106
0.90 | 114 | 84 | 114
1.00 | 112 | 92 | 122
1.10 | 110 | 100 | 130
1.20 | 108 | 108 | 138
1.30 | 106 | 116 | 146
1.40 | 104 | 124 | 154
1.50 | 102 | 132 | 162
1.60 | 100 | 140 | 170
1.70 | 98 | 148 | 178
1.80 | 96 | 158 | 188

Part d: 10 million pounds

Explanation
a. The equilibrium occurs where the quantity demanded and the quantity supplied are the same. This occurs where the demand curve and supply curve intersect. In this case, the equilibrium price is $1.20 and the equilibrium quantity is 108 million pounds.

b. There is no surplus. The market price is above the price floor; therefore, the market is in equilibrium and the price floor is nonbinding.

c. When the cost of feeding cows decreases, the supply of butter will increase by 30 million pounds at every price. To show this in the table, take the initial quantity supplied at each price and add 30 to it to get the new quantity supplied. For example, at a price of $0.80, the initial quantity supplied is 76 and adding 30 to 76 gives the new quantity supplied of 106. Enter this amount in the table in the "New" column at the price of $0.80. Do this for each of the prices, so at $0.90 add 30 to 84, which gets a new quantity of 114. Continue this process for each price.

d. After the change in supply, the new equilibrium would occur at a price below the price floor of $1.00 per pound. Therefore, the market will move to the price floor of $1.00 per pound. At a price of $1.00 per pound, the quantity supplied with the "New" supply curve is 122 million pounds and the quantity demanded is 112 million pounds. Therefore, 122 million pounds - 112 million pounds gives a surplus of 10 million pounds.
Assume the government taxes packs of cigarettes both to discourage cigarette smoking and to raise tax revenue. The average excise tax on a pack of cigarettes is $2.50 per pack. The table below presents the annual demand and supply schedules, in billions of packs, both before and after the tax on packs of cigarettes.

Market for Cigarettes
Price (dollars per pack) | Quantity of Cigarettes Demanded (billions of packs) | Quantity of cigarettes supplied (billions of packs) | Quantity of Cigarettes Supplied with Tax (billions of packs)
$10.00 | 5.0 | 65.0 | 40.0
9.75 | 7.5 | 62.5 | 37.5
9.50 | 10.0 | 60.0 | 35.0
9.25 | 12.5 | 57.5 | 32.5
9.00 | 15.0 | 55.0 | 30.0
8.75 | 17.5 | 52.5 | 27.5
8.50 | 20.0 | 50.0 | 25.0
8.25 | 22.5 | 47.5 | 22.5
8.00 | 25.0 | 45.0 | 20.0
7.75 | 27.5 | 42.5 | 17.5
7.50 | 30.0 | 40.0 | 15.0
7.25 | 32.5 | 37.5 | 12.5
7.00 | 35.0 | 35.0 | 10.0
6.75 | 37.5 | 32.5 | —
6.50 | 40.0 | 30.0 | —
6.25 | 42.5 | 27.5 | —
6.00 | 45.0 | 25.0 | —
5.75 | 47.5 | 22.5 | —
5.50 | 50.0 | 20.0 | —
5.25 | 52.5 | 17.5 | —
5.00 | 55.0 | 15.0 | —
4.75 | 57.5 | 12.5 | —
4.50 | 60.0 | 10.0 | —

a. What are the equilibrium quantity and price per pack of cigarettes if there is no excise tax on cigarettes?

multiple choice
◉ 22.5 billion packs; $7.00 per pack
◉ 35 billion packs; $7.00 per pack
◉ 22.5 billion packs; $8.00 per pack
◉ 35 billion packs; $8.00 per pack

b. What are the equilibrium quantity and price per pack of cigarettes if there is a $2.50 excise tax per pack on cigarettes?

multiple choice
◉ 35 billion packs; $8.25 per pack
◉ 35 billion packs; $7.00 per pack
◉ 22.5 billion packs; $8.25 per pack
◉ 22.5 billion packs; $7.00 per pack

c. How much tax revenue does the $2.50 per pack excise tax on cigarettes generate each year?

multiple choice
◉ $56.25 billion
◉ $75.00 billion
◉ $87.50 billion
◉ None - no cigarettes will be purchased

d. By how many packs of cigarettes does quantity demanded decrease due to the excise tax on cigarettes?

multiple choice
◉ 22.5 billion packs per year
◉ 25 billion packs per year
◉ 12.5 billion packs per year
◉ 35 billion packs per year

e. By how much did the price paid by consumers change due to the tax on cigarettes?

multiple choice
◉ $0.50 per pack
◉ $1.25 per pack
◉ $7.00 per pack
◉ $2.50 per pack
Part a: 35 billion packs; $7.00 per pack

Part b: 22.5 billion packs; $8.25 per pack

Part c: $56.25 billion

Part d: 12.5 billion packs per year

Part e: $1.25 per pack

Explanation
a. The equilibrium occurs where the quantity demanded and quantity supplied are the same. Graphically, this occurs where the demand curve and supply curve intersect. In this case, the equilibrium price is $7.00 per pack and the equilibrium quantity is 35 billion packs.

b. To find the new equilibrium quantity with the tax, it occurs where the new supply curve with the tax and the demand curve intersect. In this case, the equilibrium price is $8.25 per pack and the equilibrium quantity is 22.5 billion packs.

c. The amount of tax revenue collected is equal to the quantity sold in the market multiplied by the amount of the tax. In this case, the market quantity sold is the new equilibrium quantity with the tax, which is 22.5 billion packs times the tax of $2.50 per pack: 22.5 billion packs × $2.50 = $56.25 billion in tax revenue.

d. The original equilibrium quantity demanded was 35 billion packs and the new equilibrium quantity demanded with the tax is 22.5 billion packs. Because of the tax, the quantity demanded fell from 35 billion packs to 22.5 packs, so the quantity demanded fell by 12.5 billion packs.

e. The original price paid by consumers in equilibrium was $7.00 per pack but with the tax the equilibrium price price paid by consumers is $8.25 per pack. Therefore, the price paid by consumers increased by $1.25 per pack.
Figure:
CS (0, 100), (0, 550), (60, 250)
PS (0, 100), (0, 150, (20, 150)
ESeq (0, 150), (0, 550), (20, 450), (20, 150)

Part a:
Quantity demanded: 80 game consoles

Part b:
Quantity supplied: 20 game consoles

Part c:
Consumer surplus: $ 7000

Part d:
Producer surplus: $ 500

Part e:
Economic surplus: $ 7500

Part f:
Economic surplus in equilibrium: $ 13500

Explanation
a, b. A $150 price does not create an equilibrium. Quantity demanded is 80 game consoles and quantity supplied is 20 game consoles. Note that what is not supplied cannot be traded even if the quantity demanded is bigger than the quantity supplied. Therefore, the quantity traded is 20 game consoles.

c. Consumer surplus is the area above the price ($150), but below the demand curve ($450), left from the quantity traded (20) and right of the vertical axis. Here the area consists of a rectangle (20 × ($450 - $150) = 6,000 ) with a triangle on top (1/2 × 20 × ($550 − $450) = 1,000). Therefore, consumer surplus adds up to $7,000.

d. Producer surplus is the area below the price ($150) to the supply curve ($100), left from the quantity traded and right of the vertical axis. Here the area is a triangle: 1/2 × 20 × ($150 − $100) = $500.

e. Economic surplus is the sum of consumer and producer surplus: $7,000 + $500 = $7,500.

f. Economic surplus is the sum of consumer surplus and producer surplus. In equilibrium, the price would be $250 and the equilibrium quantity would be 60.

Consumer surplus is: 1/2 × 60 × ($550 − $250) = $9,000.

Producer surplus is: 1/2 × 60 × ($250 − $100) = $4,500.

Thus, economic surplus would be $13,500.