Public Management Economics: What is the equilibrium price

Subject: Economics    / General Economics
Homework 4: Perfect Competition
SPEA-V 517: Public Management Economics
Question 1 (15 points)
The demand curve for ski lessons is given by qD = 100 ? 2pD and the supply curve is given by qS = 3pS .
1. What is the equilibrium price? What is the equilibrium quantity?
2. A tax of $10 per ski lesson is imposed on consumers. Solve for the new equilibrium quantity and
determine the equilibrium price pD paid by consumers and the equilibrium price pS received by the
3. A senator from a mountainous state suggests that although ski lesson consumers are rich and deserve
to be taxed, ski instructors are poor and deserve a subsidy. He proposes a $6 subsidy on production
while maintaining the $10 tax on consumption of ski lessons. Would this policy have any different
effects for suppliers or for demanders than a tax of $4 per lesson? Hint: A subsidy can be considered
a negative tax, i.e., if imposed on the producer, the supply curve would shift to the right.)
Question 2: Multiple Plants (15 points)
The following questions ask you to consider the market for “Regular Coffee” and “Fair Trade Coffee”. Fair
Trade USA defines “fair trade” as follows:
“Fair Trade goods are just that. Fair. From far-away farms to your shopping cart, products that
bear our logo come from farmers and workers who are justly compensated. We help farmers in
developing countries build sustainable businesses that positively influence their communities.”
Suppose that there is an advertising campaign that promotes the purchase of fair trade coffee. Assume that
the marketing campaign works and that it influences the demand for “Fair Trade Coffee”, i.e., consumers
change their tastes and some consumers switch to “Fair Trade Coffee.”
1. Draw two supply and demand graphs; one for “Fair Trade Coffee” and one for “Regular Coffee.”
Assume that both markets are in equilibrium before the marketing campaign. Mark the equilibrium
price and quantity.
2. Show the new equilibrium quantity and price in the graph for the “Fair Trade Coffee.”
3. Illustrate the effects in the market for “Regular Coffee.” Show the new equilibrium quantity and price
in the graph for the “Regular Coffee.” What conclusions do you draw? How does the zero-economic
profit condition affect the market for “Regular Coffee?”
Question 3 (15 points)
Consider the following short-run market situation. The market is competitive and all firms are identical. The
initial market price is at p1 .
1 Market
Price Firm
S1 Dollars
AVC p1 Demand
Quantity Quantity 1. In the current market environment, does the individual firm make an economic profit or loss? Show
the area corresponding to the loss or profit graphically in the above picture.
2. Show the equilibrium condition in the long run? What happens to demand and supply? What happens
to the market price? What will be the economic profit or loss in the long run? Support your answer in
the graph.
Question 5 (15 points)
The demand curve for the daily edition of the Lubbock Avalanche Journal is D = 85, 000 ? 30, 000P. The
current price of the newspaper is $0.50. Derive the Consumer Surplus for the newspaper.
Question 6 (20 points)
Suppose you are Joe, one of many souvenir shop owners in a town centered around tourism. All souvenir
shop owners face the same decreasing returns to scale production technology as well as recurring annual
fixed costs, and they all sell a single local novelty x that is identical across all shops. Assume at the outset
of each part below that the souvenir shop market in this town is in long run equilibrium and treat each part
separately – i.e. do not carry what you concluded in one part into the next. Use graphs to justify your
answers, i.e., use graphs that represent the firm and the market.
1. The Disney Corporation has set up a new theme park in a town 20 miles away and, as a result,
a fraction of tourists that used to stay in your town are now staying elsewhere on their vacation.
What happens to your price and output in the market and in Joe’s business in the short and long run
(assuming that you remain open for business)? Can you tell whether the number of souvenir shops in
your town increases or decreases?
2. A new mayor in your town lowers recurring annual business license fees. What happens to the price
and output in the market and Joe’s business in the short and long run? Will the number of souvenir
shops in the town increase or decrease?
Question 7: School Vouchers and the Private School Market (20 points)
In the U.S., private schools charge tuition and compete against public schools that do not. One policy
proposal that is often discussed involves increasing demand for private schools through school vouchers. A
2 school voucher is simply a piece of paper with a dollar amount V that is given to parents who can pay for
some portion of private school tuition with the voucher if they send their child to a private school. (Private
schools can then redeem the vouchers for a payment of V from the government.) Assume throughout that
private schools strive to maximize profit. Suppose private schools have U-shaped average (long run) cost
curves, and the private school market in a metropolitan area is currently in long run equilibrium (in the
absence of private school vouchers).
1. Begin by drawing a schools average long run cost curve (with the number of private school seats on
the horizontal axis). Then, in a separate graph next to this, illustrate the city-wide demand curve for
seats in private schools as a function of the tuition price p. Finally, include the short run aggregate
supply curve that intersects with demand at a price that causes the private school market to be in long
run equilibrium.
2. Illustrate what happens to the demand curve as a result of the government making available vouchers
in the amount of V to all families who live in the city. What happens to the number of seats made
available in each existing private school, and what happens to the tuition level p in the short run?
3. Next, consider the long run when additional private schools can enter the market. How does the
tuition level p, the number of seats in each school and the overall number of children attending private
schools change?
4. Opponents of private school vouchers sometimes express concern that the implementation of vouchers
will simply cause private schools to increase their tuition level and thus cause no real change in who
attends private school. Evaluate this concern from both a short and long run perspective.
5. Proponents of private school vouchers often argue that the increased availability of private schools
will cause public schools to offer higher quality education. If this is true, how would your answers to
(2) and (3) change as a result?
6. If private school vouchers are made available to anyone who lives within the city boundaries (but not
to those who live in suburbs), some families who previously chose to live in suburbs to send their
children to suburban public schools might choose instead to live in the city and send their children to
private schools. How would this affect your answers to (2) and (3)? 3