Question

1. Deadweight Loss] Suppose the market for corn in Banana Republic is competitive. The domestic supply and demand function of corn is Qs = 10P and Qd = 100 − 10P, respectively. Both of them measured in billions of bushels per year.

   1. (a) Calculate the equilibrium price and quantity, consumer surplus (CS), and producer surplus (PS).

   2. (b) Suppose the government offers a subsidy of $2 per bushel to the firms. In equilibrium, the consumers are paying $4 per bushel and the firms receive $6 per bushel. Draw a graph, show the CS, PS, and DWL in this situation. (Do NOT calculate the CS, PS and DWL

Answer 1

Given: Qs = 10P and Qd = 100 − 10P

(a) The equilibrium occurs where

Qs = Qd

10P = 100 - 10P

20P = 100

P = 100/20 = 5

and Q 10(5) = 50

Thus, equilibrium price = $5 per bushel and Q = 50 billions of bushels of corn

Consumer surplus = (1/2) * (maximum willingness to pay - equilibrium price) * equilibrium quantity

CS = (1/2) * (10 - 5) * (50) = $125 per billions of bushels

Producer Surplus = (1/2) * (equilibrium price - minimum willingness to sell) * equilibrium quantity

PS = (1/2) * (5 - 0) * (50) = $125 per billions of bushels

(b) When a subsidy of $2 is given to the firms, the supply curve shifts to the right. This situation is shown in the diagram below: