Econ 50: Modified Section 2

October 2, 2015

1 Office Hours

Fanqi Shi: Thursday 3:30-5:30 p.m. (Economics 139)

2 Key Points from Class

dA
100% dA B
1. Elasticity: A,B = A
dB
100%
= dB A (own-price/income/cross-price elasticity)
B

Intuition: Compare percentage changes

Application: Elasticities and revenue/expenditure

2. Individual and Market Demand: Horizontal sum (also beware of different ranges)
Example (from class): Two individuals A and B, with demand curves QA = 10 21 P ,
QB = 12 P . What is the market demand curve QM ?
(graph here)

A substantial part of these notes is based on notes from a previous TA. These notes are at best a
summary of the section. They are not intended to and will not serve as a substitute to attending the section.

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 Exercise: How about adding a third individual C, with QC = 20 2P ?

3 Production Quotas

Here is a graph that explains well how production quotas can reduce the total surplus in
the economy. We will compare consumer and producer surplus under a free market and
under a market where production quotas place a cap on the amount of output that can be
produced.

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4 Practice exam question

Consider a small closed economy in which the demand for cars is given by

Qd = 20 2P

and the supply of cars is given by

Qs = P 2 .

1) Graph supply and demand and solve for equilibrium price and quantity.
Now suppose the government opens up the economy, allowing cars to be imported and
exported.

2) Suppose the world price of cars is above the equilibrium price found in part 1.
What will happen to domestic price? Will domestic consumer surplus increase or
decrease? What about domestic producer surplus? Explain.

Assume now the world price of cars is 4.

3) What will the total quantity of cars consumed domestically be? What will
domestic consumer surplus now be? Domestic producer surplus?
4) The government is concerned that the low world price is hurting domestic
producers and imposes a tariff of 1 on all imported cars. Calculate the new
equilibrium quantity sold domestically. What is the value of government revenue
earned from the tariff?
5) Suppose the government decides to replace the tariff with an import quota that
achieves the same equilibrium quantity in the domestic market. What level of
quota should the government set?
6) Who are the winners and losers when the tariff is replaced by the quota?

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5 Practice exam question solutions

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