Question

Suppose the government of the island has decided to give consumers a more attractive price for tomatoes by imposing a fixed, per unit subsidy. Thus, start with the original demand (Qd = 600 - 100P) and supply (Qs = 50P) and analyze this new intervention, the subsidy. The subsidy works like this: each tomato seller receives a 3-dollar refund for each tomato sold.

• Write down the equation for the new "effective supply" curve.

• Determine the new equilibrium quantity and equilibrium price.

• What is the price that the consumers will pay for their tomatoes? What is the price that the producers will effectively earn for their tomatoes, inclusive of the subsidy?

• Graphically depict the new equilibrium complete with (solved) values for the new price and quantity. (Label the original supply as S1 and the new “effective supply” as S2).

Answer 1

(a)

New supply curve: QS1 = 50 x (P + 3)

QS1 = 50P + 150

(b)

Setting QD = QS1,

600 - 100P = 50P + 150

150P = 450

P = 3 (Price paid by buyers)

Price received by sellers = 3 + 3 = 6

Q = 600 - 100 x 3 = 600 - 300 = 300

(c)

Before subsidy, QD = QS

600 - 100P = 50P

150P = 600

P = 4

Q = 50 x 4 = 200

When QD = 0, P = 6 and when P = 0, QD = 600.

When QS = 0, P = 0 and when P = 0, QD = 0.

When QS1 = 0, P = - 3 and when P = 0, QS1 = 150.

In following graph, initial equilibrium is at point A where D1 intersects S1 with price P1 and quantity Q1. After subsidy, equilibrium is at point B where D1 intersects S2 with price paid by buyers being P2, price received by sellers being P3 and quantity being Q2.