Question

Consider a competitive market for good 1 that includes 50 identical consumers and 50 identical firms.

Each consumer has a utility function u(x,v) = 5 ln (x + 1) + v and a budget constraint is px + v =< 5 (x is his consumption of good 1, v is his consumption of other goods, and p is the market price for potatoes.)

To produce good 1, each firm has the cost function  C(y) = 5y (y is the firm’s output.)

To support the good 1 industry, the government decides to pay a subsidy of 1 per unit (produced) to the firms.

(a) What are the equilibrium price and quantity before the subsidy, and after the subsidy

(b) Calculate how much this subsidy changes the consumers’ surplus (CS), the producers’ surplus (PS), and the government revenues. Calculate the deadweight loss (DWL).

Answer 1