Price Floors & Price Ceilings, Indirect Tax, Subsidy Cheat Sheet (Updated)

Price Floors & Price Ceilings, 

Indirect Tax, Subsidy 

Cheat Sheet (Updated) 

Price Floors & Price Ceilings

Price Floors & Price Ceilings

Floors are High !

Say it again, Floors are High !

One more time, Floors are High !

A price floor is the lowest price that a supplier can charge for its good.

The price floor above is at $5, which mean that the $5 is the minimum price that the supplier can charge for its good. Governments often interfere in the market by passing laws that require producers (suppliers) to charge minimum prices. This price protects the suppliers in that no business can now charge less than the minimum price.

If a business decides to sell its good for less than the $5, the business owner might be fined or sent to jail.

Jacob Meged was a tailor of Polish descent who had a tailor shop at 138 Griffiths Street in Jersey City. He had a wife and four children and he needed money to feed his family.  Other tailors were charging 40 cents, but he wanted to get more business, so he put a sign in his shop window advertising that he would press suits for 35 cents. After all, this was America where you were accustomed to being free to charge what you want.  Beating the competition and being entrepreneurial was the American way, and he would be happy to press suits for 35 cents.  Unfortunately, Jacob didn’t get more business and instead, he was arrested.J. Raymon Tiffany, Special Assistant Attorney General in charge of enforcing NRA codes in New Jersey took responsibility for prosecuting the tailor. When Jacob Meged was read the charges, he told Judge Kinkead that he was only vaguely aware of the existence of a code, but he pled guilty to the charge that he had violated the New Jersey State Recovery Act.  Mr. Tiffany asked the court to impose a sentence stiff enough to warn other code violators that the law had teeth in it.

On Friday, April 20, 1934, Judge Robert V. Kinkead sentenced Jacob Meged to 30 days in the county jail, and he was ordered to pay a $100 fine.   At 40 cents a suit, Meged would have to press 250 suits to cover his fine.  That would be $100 he couldn’t use to feed his family, and in addition to this, he would lose a month’s earnings.

As The New York Times put it, “He believed that the codes were designed to help the ‘little fellow’ and could not believe that by charging 35 cents instead of 40 cents to press a suit would put him behind bars. In court yesterday he stood as if in a trance when sentence was pronounced.  He hoped that it was a joke.”

A price floor below the equilibrium point (market clearing price) is NOT  an effective or binding price floor.

Understand:

If the minimum price (price floor) is set below the equilibrium market clearing point it will have no effect as the market has already cleared.

Jung Sub: I don't get it.

Mr. Waugh: Picture this,, at the $3 price Jung Sub buys all the jars of pinto beans that I'm selling.

I'm happy and Jung Sub is happy. The market has cleared.

Then a government employee walks in the room and says that we can't sell beans for less than $1 per jar. The $1 minimum required price had no effect on the market (IT WASN'T EFFECTIVE), IT MADE NO DIFFERENCE.

2017 AP Microeconomics FRQ #1

2017 AP Microeconomics FRQ #1

Watch me anser it here

https://youtu.be/VTWkhHORmGc

(A) Draw a CLG for the corn market and a representative corn farmer (Firm). On your graph show each of the following.

(i) The equilibrium price and quantity in the corn market, labelled PM & QM.

(ii) The profit maximising quantity of corn produced by the representative farmer earning zero economic profit (normal profit) labelled QF.

 Answer

(B) Assume the demand for ethanol increases. On your graph in part (A) show what will happen to each of the following in the short-run

(i) The market price and quantity of corn labelled P* & Q*.

(ii) The area of profit or loss earned by the corn farmer. Shaded completely.

If the demand for Ethanol increases then the demand for corn must increases as corn is an input for Ethanol.

Answer

(C) Relative to your answer in part (B), state what will happen to the market equilibrium price and quantity of corn in the long-run. Explain.

Profits in the short run, attract firms

Firms enter in the long-run

Firms enter and produce more Supply, Supply increases

Increased Supply means quantity produced increases

Increased Supply drives prices lower

Answer

(D) Soybeans are produced in a perfectly competitive market. Assume farmers can grow either corn or soybeans on the same land. What happens to the price of soybeans in the next planting season if the price of corn increases? Explain.

Ok, if the price of corn increases farmers will want to plant more of it as the profits on each bushel will be greater than on a bushel of soy beans. So farmers switch from soybean production to corn production hunting for profits. This reduces the supply of soybeans in production. Less supply means hire prices for soybeans.

Corn and Soybeans are considered competitively (supplied) produced goods.

Answer

(E) Assume instead that the government sets a binding price ceiling in the corn market.

Draw a new CLG of the corn market and show each of the following.

(i) The binding price ceiling, labelled PC.

(ii) The quantity purchased by consumers in the corn market, labelled QC.

Understand that a binding price ceiling is one that is below the equilibrium point. Binding also means effective which implies it must effect the market and an effective price ceiling is one that is below equilibrium.

Remember that ceilings are low, and floors are high.

Answer

2008 Micro FRQ #3

2008 Micro FRQ #3

(A) For a competitive market for which there is a binding (effective) price ceiling , draw a CLG and label the price ceiling Pc & the quantity sold, Qa, and the socially efficient output Qb.

(B) (i) Using the labelling in the graph, identify the profit-maximising output and the socially efficient output. (Output means Quantity)

(B) (ii) At the socially efficient output is the monopoly making a profit or incurring a loss. Identify the area of profit or loss.

2015 AP Microeconomics Exam FRQ #3

2015 AP Microeconomics Exam FRQ #3

Watch me answer it here

https://youtu.be/2cVGLqggiwM

(a) Calculate the total producers surplus at the market equilibrium price and quantity. 

Area of triangle   = (h * b/2)  or (1/2 height * base)

so, 20 (height) X 20 (base)/ 2 = 20*20 =400/2 = 200

Answer - 20*20 = 400/2 = 200 (total producers surplus)

AP - Answer - One point is earned for calculating the total producer surplus as (1/2 × 20 × 20) = $200.

(b) If the government imposes a price floor at $16, is there a shortage, surplus or neither?

Remember (floors are high and ceilings are low). A price floor set below the equilibrium price will have no effect as the market will clear.

Answer - at a $16 price floor neither a surplus or a shortage will occur because the $16 is below the equilibrium price,, it is not an effective or binding price floor.

AP - Answer - One point is earned for stating that imposing a price floor at $16 is ineffective and will not create a surplus or a shortage in the market because it is set below the equilibrium price, or because it is not binding 

(c) If instead the government imposes a price ceiling at $12, is there a shortage, a surplus or neither? 

A price ceiling is a government-imposed price control or limit on how high a price is charged for a product. 

So, the highest price that can be charged for the widgets is $12. At the low price of $12 suppliers will only provide 12 units of this good,, but at the low price of $12 people will demand 24 units. So there will be a shortage.

AP - Answer - One point is earned for stating that imposing a price ceiling at $12 will create a shortage because quantity demanded is greater than quantity supplied, or because the price ceiling is binding. 

(d) If instead the government restricts the market output to 10 units, calculate the deadweight loss.

Understand that a 10 unit restriction on output is represented by a perfectly inelastic supply curve at the 10 unit quantity. All the people/quantity to the right of the 10 unit limit will not be served/produced,, thus it is allocatively inefficient and therefore the efficiency is represented by deadweight loss. 

Area of Triangle = b*h/2

height = 40-10 = 30

base = 20-10 = 10

30*10 = 300/2 = 150

AP - Answer - One point is earned for calculating the deadweight loss as $150 and for showing:

(1/2 × 30 × 10) or

(1/2 × 10 × 10) + (1/2 × 20 × 10) or

$50 + $100 

(e) Assume the price decreases from $20 to $12.

(i) Calculate the PED

(ii) Is demand perfectly elastic, relatively elastic, unit elastic, perfectly inelastic or relatively inelastic?

2011 AP Microeconomics Exam FRQ #1

2011 AP Microeconomics Exam FRQ #1

Watch me answer it here

           https://youtu.be/U7lTP-vGStA

(a) Assume that the monopolist wants to maximise profits. Using the labelling on the graph, indicate the monopolist's price.

Profit max = MR = MC

Answer - One point is earned for identifying the profit-maximizing price as $24. 

(b) When the output is $8, what is the profit per unit?

Profit per unit  = TR - TC/ # units

TR = 8 x 24 = 192

ATC @ 8 units of production (follow the line up until you bump into the ATC curve.

ATC @ 8 units = $18 per unit or (8x18 = 144)

TR - TC = (192 - 144 = 48)

48/8 = 6

Profit per unit = $6

Answer - One point is earned for identifying the profit per unit as $6.

(c) Assume the monopolist is maximising profit. Is allocative efficiency achieved.

Demand = Price

 Answer - One point is earned for stating that allocative efficiency is not achieved because 

price is not equal to MC or MC is not equal to demand. 

(d) Between the price of $16 & $18, is the monopolist in the elastic, inelastic or unit elastic section of the demand curve?

Answer - One point is earned for stating that the demand is inelastic because total revenue increases as price increases from $16 to $18, or because the price elasticity of demand within the price range is less than 1, or because marginal revenue is negative. 

(e) Assume the regulators set an output of 11 units.

(i) Is the monopolist earning positive economic profits?

(ii) Is the monopolist earning positive accounting profits?

If the monopolist is forced to produce 11 units he will just be covering his costs, accounting profits will be covered (explicit) but implicit costs (opportunity costs) will not be covered. As there is no entrepreneurial profit.

Answer - One point is earned for indicating that the monopolist is not earning positive economic profit, because price equals average total cost. One point is earned for indicating that the monopolist is earning positive accounting profit. 

(f) Assume the regulator imposes a price ceiling of $22.

(i) What is the marginal revenue for the 8th unit?

(ii) What quantity will be produced?

Answer - One point is earned for stating that the marginal revenue of the 8th unit is $22.
One point is earned for stating that 9 units will be produced. 

(g) Assume instead that the monopolist practises first-degree price discrimination (also called perfect price discrimination).

(i) What quantity will be produced?

(ii) What will be the consumers surplus.

8 units produced.

10 units produced

Perfect Price Discrimination = More profit

Each customer is charged the max he will pay, so zero consumer surplus

MR is the Market Price since the firm doesn't have to lower the price to sell more, P = MC = MR

More output produced so (10 units produced), Greater allocative efficiency

Answer - One point is earned for stating that 10 units will be produced.

One point is earned for stating that the consumer surplus is zero. 

2006 AP MIcro FRQ#2

2006 Price Ceiling - FRQ#2

Watch me do this FRQ on youtube https://youtu.be/Ux4F3PnCg4w

(A) Using a correctly labeled graph of supply and demand, show each of the following

We see the same pattern being used here. First questions are asked, usually, before any tax, tariff, subsidy happens.

• The equilibrium price and quantity, labeled as P* and Q*. Respectively  -- (Respectively is used when enumerating two or more items or facts that refer back to a previous statement). 

• area representing consumer surplus, labeled CS
• area representing the producer surplus, labeled PS

Simple enough, yes. but  1point is awarded for the CLG - Correctly Labeled Graph

                                         1point is awarded for the labeling of the CS (consumer surplus)

                                         1point is awarded for the labeling of the PS (producer surplus)

(B) The government imposes an effective(binding) price ceiling. Redraw your graph in       part (a), and label the ceiling price as P2. Completely shade the area representing       the sum of the consumer surplus and the producer surplus after the imposition of       the price ceiling.

We can see that with a binding (below equilibrium) price ceiling at P2,,, only Q1 of quantity will be supplied.

The quantity demanded is Q2 but the amount from Q1 to Q2 will never be supplied at this price.

At the low price of P2 consumer surplus has increased and gained the lower square.

Producer surplus has shrank to the small lower shaded triangle.

I want to point out that the white triangle (unshaded) to the left of the old equilibrium price is now considered DWL or dead weight loss. It represents the consumers and producers who would have liked to buy or sell at a higher price but can't now due to government intervention. 

(C) Suppose the demand for home security systems decreases and the price ceiling remains binding. Indicate what will happen to consumer and producer surplus.

So if Demand decreases, the demand curve shifts left. But, because they say in the problem (the price ceiling remains binding) we know that the demand curve has NOT shifted below the P2 price ceiling. Shifting the demand curve will decrease the consumer surplus but the producer surplus will remain unchanged. The producer surplus will only be effected if the supply curve shifts,, or the demand curve shifts far enough to cause the equilibrium price to go lower than P2.