Question

) Use the following information for the market for bananas.

Supply and demand curves are linear

Supply is steeper than supply

Demand intersects the price axis at 36

Supply intersects the price axis at 6

The equilibrium price is 24 and the equilibrium quantity is 6

a) Draw a supply and demand model of the market for bananas. Be sure to show the equilibrium quantity and price.

b) Calculate the market’s CS, PS, and TS.

c) Assume a binding price floor is enforced in the banana market at a price of $30. At the price floor, quantity demand is 3. When price is $15 quantity supply is 3.

            i) Draw a new supply and demand model showing this price floor.

            ii) Calculate CS, PS, and TS with the price floor.

            iii) Explain in words the concept of a deadweight loss?

            iv) Calculate and interpret the deadweight loss from the price floor?

v) Was the market for bananas more efficient before or after the price floor was imposed? Explain.

Answer 1

a) Graph is provided below. Equilibrium occurs at E. Price is 24 and quantity is 6

b) CS = 0.5*(36 - 24)*6 = $36. PS = 0.5*(24 - 6)*6 = $54. TS = 0.5*(36 - 6)*6 = $90.

c) If price floor is applied, there is a surplus.

i) The model is shown below.

ii) CS = 0.5*(36 - 30)*3 = $9. PS = 0.5*(15 - 6)*3 + (30 - 15)*3 = $58.5. TS = PS + CS = $67.5

iii) Deadweight loss is the loss in the efficiency when resource allocation is ineffcient and market produces a lower level of output than the market efficient.

iv) DWL = 0.5*(30 - 15)*3 = $22.5

v) Because the market has a higher total surplus before the price floor, it is more efficient