Question

Assume that the market for wheat is in equilibrium with a price of $50 per bushel and Quantity of Q₀. For each scenario, show that happens to the supply and demand for wheat and indicate whether supply and demand increases, decreases, or does not change. Also indicate what happens to the price and quantity of wheat traded. Each section is to be treated separately.

a. Drought hits hard and a large fraction of the farm land in the US and the federal government increases their purchase of wheat for use in aiding other countries.

b. Concerned about high wheat prices, the government impose a $40 per bushel price ceiling. Label the quantity traded with the price ceiling Q_T.

c. The government implements a $10 per bushel subside on the production of wheat. Clearly show an area representing the deadweight loss associated with the subsidy.

Answer 1

a) Due to the drought occurring in most parts, the supply of wheat decreases and due to the government's increased purchase of wheat, the demand increases. Together these two events shift the demand curve to the right and shift the supply curve to the left. At the new equilibrium, the price of wheat is increased but the quantity change is uncertain. We expect the size of the shifts to be same so quantity is unchanged.

b) Market equilibrium price is $50 and the government imposes a $40 per bushel price ceiling. This becomes binding and creates a shortage of wheat in the market.

c) Subsidy to producers shifts the supply curve to the right. Market equilibrium price of wheat falls and quantity is increased. However, there is an associated deadweight loss shaded by black because government expenditure is more than the increased social welfare.