Question

1. Let’s think about a per unit production subsidy. Start with an initial equilibrium price of $5 and quantity of 100 million. Now provide producers with a $1 per unit subsidy. Shade in (the cost of) the subsidy, make up numbers for the new quantity exchanged, the price consumers face (P_c) and the price producers get (P_p). Ideally you can do this without simply copying it from the book... try it over several days until you can.

2. The goal of a subsidy to labor (such as the EITC) is to both raise wages and encourage employment to support low-income families. How does the wage elasticity of demand affect the success of achieving these goals? (That is, are the goals better met if demand for labor is elastic or inelastic?) Illustrate your answer by showing a wage subsidy in two scenarios: relatively inelastic demand for labor and relatively elastic demand for labor. Assume an initial equilibrium of $10 per hour and 100 mn hours of labor employed. Also, keep in mind that the supply curve in the labor market reflects workers (supplying labor) while the demand curve reflects firms (demanding labor).

3. Assume a $1 / pack excise tax is placed on the producers of grapes. This causes the price to rise from $3 / pack to $3.80 / pack and causes quantity demanded to fall from 470 million packs per year to 400 million packs per year.

1. • Illustrate this in a S&D graph
   • What price do the producers get after the tax?
   • What is the tax revenue for the government? (answer in $ and make a bold line around it)
   • What is the price elasticity of demand for grapes? (you will need a calculator)
   • Shade in the lost consumer surplus.

Answer 1

1. When subsidy Is provided to the producers, supply curve shifts to the right, and price received by producer is more than what consumers pay after the subsidy. This can be seen through following diagram: