Chapter 7

Teaching TipsExcess Benefit and Deadweight LossNote that the concepts of excess benefit and deadweight loss are closely linked. As the total difference between marginal benefit and marginal cost for all units that are produced or consumed in a market, the concept of excess benefit has the most general application. It can be applied whenever comparisons are being made between marginal benefit and marginal cost in order to see how particular market changes are either add or subtract from the net difference between total benefits and total cost. In the chapter, this concept is used in analyzing the impact of subsidies and taxes geared to reducing spillover benefits and costs.

Deadweight loss is a measure of the reduction in excess benefit that results from policies -- such as the creation of government-sanctioned cartels, agricultural price supports, rent controls or the imposition of an excise tax in a market with no pre-existing spillover costs or benefits -- where the overall effect is a reduction excess benefit. In these cases, the deadweight loss is a measure of the size of this decrease in excess benefit.

Product Taxes and their UsesA connected issue is the double view of product taxes found in this chapter. In the discussion of spillover effects, product taxes are being used as a means to deal with spillover costs, with the aim of augmenting the excess benefit associated with a particular market. In the discussion of excise taxes, on the other hand, the purpose of imposing a product tax is distinct. Now the intent of government policy makers is to generate revenue for government operations. With no spillover costs to correct for, the impact of this form of taxation is to reduce rather than raise excess benefit in the relevant market, as shown by the deadweight loss that is created by such taxes. What the analysis of welfare effects allows policy makers to do is minimize this deadweight loss.

Global ConundrumClimate change and the ways in which economic theory can help clarify the best means to combat it is a subject that some students will find particularly fascinating. For those with a special interest in this topic, the eBook article Global Conundrum included in Chapter 7 augments the text's treatment of climate change in several ways. First, it provides a summary of some of the evidence of climate change's emerging impact as provided by climate science. Second, it outlines the ways in which the abatement of carbon emissions can be seen as a global public good. Third, the article presents a simplified model based on the assumption of a single-firm industry to show the slightly different welfare impacts of the two main policy solutions proposed for climate change -- carbon taxes and cap-and-trade schemes. This model uses the same techniques and concepts as are discussed in the chapter, but in a way that allows for a more nuanced evaluation of these two policy options.

The Wealthy and the RestOne of the most controversial topics in contemporary economics is how best to define income equity, not least because of the trend towards more unequally distributed incomes in many countries, Canada included. The eBook article The Wealthy and the Rest included in Chapter 7 provides a provocative look at these trends by highlighting the theories of French economist Thomas Piketty. Not only has Piketty done path-breaking work to refine the global collection of income distribution statistics, he provides a general model of income distribution with strong links to the theories of past economists such as Adam Smith and Karl Marx to explain the reasons behind the trend to greater inequality that we are seeing in countries such as Canada. Because both the statistics and the theoretical tools Piketty uses differ from those utilized in mainstream economic theory, this article will appeal to instructors and students interested in viewing this issue from a perspective that is distinctive in a variety of ways.

Answers to Thinking About Economics QuestionsPage 173: No. Some consumers can buy a product more cheaply as a result of price discrimination than would be the case if price-discriminating businesses instead charged all their customers the same price.

Page 179: They do so by charging those who wish to acquire addresses on the Internet.

Page 180: A demand-related reason might be a technological innovation that allows for a new use for the relevant recycled product as an input. A supply-related reason might be the increased consumption of the item that is being recycled.

Page 188: The market for unskilled labour is the one in which a set minimum wage is mostly likely to exceed the equilibrium wage rate, because wage rates in this market tend to be low.

Page 194: Using lifetime incomes rather than annual incomes would make the distribution of income appear more equal, since this would cancel out the wide fluctuations in annual income experienced by individuals over their lifetime.

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Page 196: None of these economic choices is more rational than the others. Each option merely represents different preferences concerning the acquisition of knowledge, and the timing of income flows.

Page 199: An extremely unequal distribution of income may dampen incentives to undertake such income-enhancing strategies as education or saving, since social and economic divisions make individual mobility difficult if not impossible.

Answers to Chapter Problems7.1 Practice Problem

1. a. 

b. The equilibrium price and quantity of $3 and 6 million litres are found at the intersection of D and S0 (point a on the graph).c. The initial consumer and producer surpluses can each be calculated as the areas of triangles (A + B + C) and D shown in the graph. Triangle (A + B + C)'s height is $2 (= $5 - $3), and its base is 6 million litres so the initial consumer surplus is $6 million [= ($2 x 6 million) / 2]. Triangle D has the same height of $2 (= $3 - $1) and its base is 6 million litres so the initial producer surplus also equals $6 million.d. With the supply curve S1 the new equilibrium price is $4 and the new equilibrium quantity is 3 million litres (point b on the graph).e. The new consumer and producer surpluses are triangles A and B in the graph. Triangle A's height is $1 (= $4 - $3) and its base is 3 million litres so the consumer surplus is $1.5 million [= ($1 x 3 million) / 2]. Triangle B has the same height of $1 (= $5 - $4) and its base is 3 million litres so the producer surplus also equals $1.5 million [= ($1 x 3 million) / 2].f. Due to the reduction in both the consumer surplus and producer surplus both consumers and producers have become worse off.

7.2 Practice Problems

1. a. The disturbance created by the club for nearby residents is a spillover cost.b. The subway's reduction of traffic congestion is a spillover benefit.c. Because the existence of the species is a public good poaching that leads to its extinction is a tragedy of the commons.d. The addition to soil pollution caused by throw-away batteries is a spillover cost.e. The reduction in electricity use and carbon emissions stemming from use of the new bulb is a spillover benefit.f. The higher energy use and carbon emissions associated with the new jet is a spillover cost.g. Given that email is a public good its declining usefulness as a result of proliferating spam messages is a tragedy of the commons.

2. a.

Price($ per vaccine)

Quantity Demanded(millions of vaccines per

year)

Quantity Demanded(millions of vaccines per

year)

Quantity Supplied(millions of vaccines per

year)  D0 D1 S

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14 - [0] 812 0 [2] 610 2 [4] 48 4 [6] 26 6 [8] 0

. 

b. The equilibrium price of $9 per vaccine and equilibrium quantity of 3 million vaccines per year are found at the intersection of D0 and S (point d on the graph).c. With a $2 spillover benefit for each vaccine the demand curve incorporating spillover benefits (D1) is vertically higher than the initial demand curve (D0) by $2 at every possible quantity. For example at the initial quantity of 3 million vaccines the new price is $2 above the current $9 level at $11 (point a on the graph). The preferred quantity is at the intersection of the new demand curve (D1) and the supply curve (S) with 4 million vaccines (point b in the graph).d. The excess benefit before government intervention is the difference between the demand curve D1 that incorporates the spillover benefits and the supply curve S up to the initial equilibrium quantity of 3 million vaccines. This is the area (A + B + D) in the graph. Triangle A's height is $3 (= $14 - $11) and its base is 3 million vaccines so its area is $4.5 million [= ($3 x 3 million) / 2]. Triangle D has the same height of $3 (= $9 - $6) and its base is 3 million vaccines so it also has an area of $4.5 million. Rectangle B has a height of $2 (= $11 - $9) and a width of 3 million vaccines so its area is $6 million (= $2 x 3 million). The excess benefit is the sum of all three areas. This is $15 million (= $4.5 million + $6 million + $4.5 million).e. A government-imposed $2 subsidy per vaccine shifts demand from D0 to D1 and raises the quantity of vaccines to the preferred quantity. The price as seen by producers is $10 (point b in the graph) and as seen by consumers is $8 (point c on the graph).f. The total amount spent on the subsidy is found by multiplying the new quantity of 4 million vaccines by the per unit subsidy of $2. This gives $8 million.g. After the subsidy is in place quantity rises from 3 to 4 million vaccines. This rise captures the increase in net benefit shown by triangle C in the graph. C's area can be found by dividing it into two triangles. The upper of these triangles has a height of $1 (= $11 - $10) and a base of 1 million vaccine so its area is $500,000 [= ($1 x 1 million) / 2]. The lower of these triangles has the same height of $1 (= $10 - $9) and a base of 1 million vaccines so its area also equals $500,000. The area of C is the sum of these two triangles. This equals $1 million. The new excess benefit is the area (A + B + C + D). This is the sum of the $15 million area of (A + B + D) found in part f and the $1 million area of C. So the new excess benefit is $16 million.

7.3 Practice Problem

1. a.

Price($ per kg)

Quantity Demanded(millions of kg per year)

Quantity Supplied0

(millions of kg per year)Quantity Supplied1

(millions of kg per year)

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  D S0 S1

12 - 10 [6]11 0 8 [4]10 2 6 [2]9 4 4 [0]8 6 2 [0]7 8 0 [0]

b. The initial equilibrium price and quantity of $9 and 4 million kilograms are found at the intersection of D and S0 (point c on the graph).c. With the $2 excise tax, the after-tax supply curve S1 is vertically higher than the initial supply curve S0 by $2 at every possible quantity. For example, at the initial quantity of 4 million kilograms, the new price is $2 above the current $9 level at $11 (point b on the graph). This means that quantity supplied is 0 kilograms at several possible prices -- $7, $8 and $9.d. The new equilibrium price as seen by consumers and equilibrium quantity are $10 and 2 million kilograms (point a in the graph). The price as seen by producers is $8 (point d on the graph).e. The total tax payment is the area of the rectangle (B + D) in the graph, or $4 million (= $2 x 2 million). The portion that falls on consumers (area B in the graph) is $2 million (= $1 x 2 million), while the portion that falls on producers (area D in the graph) is also $2 million (= $1 x 2 million).f. The consumer surplus and producer surplus before the tax are the areas of the triangles (A + B + C) and (D + E + F) in the graph. Triangle (A + B + C)'s height is $2 (= $11 - $9) and its base is 4 million kilograms. So the initial consumer surplus is $4 million [= ($2 x 4 million) / 2]. Triangle (D + E + F) has the same height of $2 (= $9 - $7) and base of 4 million kilograms so the initial producer surplus is also $4 million.g. The consumer surplus and producer surplus after the tax are the areas of triangles A and F in the graph. Triangle A's height is $1 (= $11 - $10) and its base is 2 million kilograms so the consumer surplus is $1 million [= ($1 x 2 million) / 2]. Triangle F has the same height of $1 (= $8 - $7) and base of 2 million kilograms so the producer surplus is also $1 million.h. Due to the tax, both the consumer surplus and producer surplus fall from $4 million to $1 million so that the loss of welfare is the same for consumers and producers.i. The deadweight loss of the tax is (C + E). Triangle C's height is $1 (= $10 - $9) and its base is 2 million kilograms so its area is $1 million [= ($1 x 2 million) / 2]. Triangle E has the same height of $1 (= ($9 - $8) and base is 2 million kilograms so its area is also $1 million. The deadweight loss is the sum of these two amounts combined, or $2 million.

7.4 Practice Problems

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1. a. 

b. The initial equilibrium price and quantity of $0.80 and 60 million kilograms are found at the intersection of D and S (point a in the graph). Consumers' total expenditure and producers' total revenue are both equal to the area of the rectangle (C + D) in the graph whose height is $0.80 and width is 60 million litres. This amount is $48 million (= $0.80 x 60 million).c. The $0.90 price support creates an annual surplus of 20 million (= 70 million - 50 million) litres. This is the distance between points b and c in the graph.d. Consumers are made worse off by the program because they buy less of the product at a higher price. Their total expenditure is the area of the rectangle (A + C) in the graph. This rectangle's height is $0.90 and its width is 50 million litres so the new consumer expenditure is $45 million (= $0.90 x 50 million). Producers benefit through selling a higher quantity at a higher price. Their total revenue becomes the area of the rectangle (A + B + C + D + E). This rectangle's height is $0.90 and its width is 70 million litres so the new total revenue for producers is $63 million (= $0.90 x 70 million).e. The cost of the program to taxpayers is the government's total expenditure to purchase the surplus. This is the area of the rectangle (B + D + E) in the graph. This rectangle's height is $0.90 and its width is 20 million (= 70 million - 50 million) litres so the total cost to taxpayers is $18 million (= $0.90 x 20 million).

2. a. 

b. The initial equilibrium rent and quantity of $1,200 and 40,000 units are found at the intersection of D and S (point a in the graph).c. The $800 price ceiling creates a shortage of 20,000 (= 30,000 - 50,000) units, as shown by the distance between points b and c in the graph. Tenants who are able to find units at the ceiling price are made better off because they pay less than the original $1,200 price. Landlords are made worse off because of this reduction in rent.d. Total revenue before controls is $48 million. It is found by multiplying the initial rent of $1,200 by the initial quantity of

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40,000 units. Total revenue after controls are imposed becomes $24 million. This is found by multiplying the new rent of $800 by the new quantity of 30,000 units.

7.5 Practice Problems

Household 1 2 3 4 5

Annual Income ($) 5,000 10,000 15,000 30,000 40,000

Share of income (%) [5] [10] [15] [30] [40]

Cumulative share of income (%) [5] [15] [30] [60] [100]

1. a. Total income earned in Libra is $100,000 (= $5,000 + $10,000 + $15,000 + $30,000 + $40,000). The shares of income earned by the five households are 5% [= ($5,000 / $100 000) x 100%], 10% [= ($10,000 / $100,000) x 100%], 15% [= ($15,000 / $100,000) x 100%], 30% [= ($30,000 / $100,000) x 100%], and 40% [= ($40,000 / $100,000) x 100%].b. The cumulative shares of income earned by each household are 5%, 15% (= 5 + 10), 30% (= 5 + 10 + 15), 60% (= 5 + 10 + 15 + 30) and 100% (= 5 + 10 + 15 + 30 + 40).c. 

2. a. The Albertan carpenter probably earns more. This is primarily due to regional disparities.b. The truck driver probably earns more. This is primarily due to more unpleasant job conditions.c. The postal worker probably earns more. This is primarily due to the fact that the postal worker is unionized while the courier company employee is probably not unionized.d. The warehouse clerk probably earns more. This is primarily due to discrimination on the basis of gender. While restaurant jobs are dominated by low-paid female labour, warehouse clerks are usually men.e. The lawyer probably earns more. This is primarily due to the greater amount of education required to be a lawyer.f. The clerk who works on commission probably earns more. This is due to the higher income needed to remunerate the risks associated with commission income.g. The landlord probably earns more. This is primarily due to their greater ownership of wealth.

End of Chapter Problems 1. a.

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b. The equilibrium price and quantity of $1.50 and 2 million kilograms are found at the intersection of D and S (point a in the graph).c. The initial consumer surplus and producer surplus are the areas of the triangles (A + B + C) and (D + E) in the graph. Triangle (A + B + C)'s height is $1 (= $2.50 - $1.50), and its base is 2 million kilograms so the initial consumer surplus is $1 million [= ($1 x 2 million) / 2]. Triangle (D + E) has the same height of $1 and its base is 2 million kilograms so the initial producer surplus also equals $1 million.d. The equilibrium price at the restricted quantity of 1 million kilograms is $2 (point b in the graph).e. The transfer of consumer surplus to producer surplus is the area of rectangle B in the graph. This rectangle's height is $0.50 (= $2 - $1.50) and its width is 1 million kilograms so the transfer of consumer surplus to producer surplus equals $500,000 [= ($0.50 x 1 million)]. The deadweight loss is the area of triangle (C + E) in the graph. Triangle C's height is $0.50 (= $2 - $1.50) and base is 1 million kilograms so its area is $250,000 [= ($0.50 x 1 million) / 2]. Triangle E has the same height of $0.50 (= $1.50 - $1) and base of 1 million kilograms so its area also equals $250,000. The sum of these two triangles is $500,000.f. The transfer of consumer surplus to producer surplus means that consumers are worse off and producers still operating in the market are better off due to the output restriction.g. The deadweight loss is a dollar estimate of how much society as a whole is made worse off by the output restriction.

2. a.

Price($ per kg)

Quantity Demanded(millions of kg per year)

Quantity Supplied0

(millions of kg per year)Quantity Supplied1

(millions of kg per year)  D S0 S1

12 0 20 [16]10 4 16 [12]8 8 12 [8]6 12 8 [4]4 16 4 [0]2 20 0 [0]

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b. The initial equilibrium price and quantity of $7 and 10 million packs are found at the intersection of D and S0 (point a on the graph).c. With the $2 excise tax the after-tax supply curve S1 is vertically higher than the initial supply curve S0 by $2 at every possible quantity. For example, at the initial equilibrium quantity of 10 million packs, the new price is $2 above the current $7 level at $9 (point b on the graph). This means that quantity supplied on S1 is 0 packs at two possible prices -- $4 and $2.d. The excess benefit before the tax is the difference between D and the supply curve S1 that incorporates the spillover costs. This includes all the area of triangle A in the graph. Because S1 is above D between the quantities 8 million and 10 million the triangle B represents a negative excess benefit whose area must be deducted from the area of triangle A. Triangle A can be treated as two identical triangles. The first has a height of $4 (= $12 - $8) and a base of 8 million packs so its area is $16 million [= ($4 x 8 million) / 2]. The second triangle has the same height of $4 (= $8 - $4) and a base of 8 million packs so also has an area of $16 million. So triangle A has a total area of $32 million.Triangle B can be treated as two identical triangles. The first triangle has a height of $1 (= $9 - $8) and a base of 2 million packs so has an area of $1 million [= ($1 x 2 million) / 2]. The second triangle has the same height of $1 [= ($8 - $7) / 2] and a base of 2 million packs so its area is also $1 million. This means triangle B has a total area of $2 million. Total excess benefit is the difference between triangles A and B and is therefore $30 million (= $32 million - $2 million).e. A $2 tax shifts supply from S0 to S1 and reduces the quantity of cigarettes to the preferred quantity. The price as seen by consumers is $8 (point d in the graph) and as seen by producers is $6 (point c on the graph).f. The total revenue from the tax is found by multiplying the new quantity of 8 million packs by the $2 tax, or $16 million.g. After the tax is in place, quantity falls from 10 to 8 million. This drop extinguishes the negative excess benefit shown by the area of triangle B. This means the excess benefit in this market is now the full area of triangle A which is $32 million.

3. a. The initial equilibrium price and quantity of $1.80 and 12 million shakes are found at the intersection of D and S0 (point c in the graph).b. The amount of the excise tax is shown by the vertical distance between S0 and S1. The after-tax supply curve S1 is $0.30 higher than S0 at every possible quantity. For example at the initial quantity of 12 million shakes price rises from $1.80 to $2.10 (point b on the graph). So the tax is 30 cents per shake.c. The new equilibrium price as seen by consumers and quantity are $1.90 and 8 million shakes (point a in the graph). The price as seen by producers is $1.60 (point d on the graph).d. The total tax payment is area (B + D) in the graph, or $2.4 million (= $0.30 x 8 million). The portion that falls on consumers (area B in the graph) is $800,000 (= $0.10 x 8 million) while the portion that falls on producers (area D in the graph) is $1.6 million (= $0.20 x 8 million).e. The consumer surplus and producer surplus before the tax are the areas of triangles (A + B + C) and (D + E + F) in the graph. Triangle (A + B + C)'s height is $0.30 (= $2.10 - $1.80) and its base is 12 million shakes so the initial consumer surplus is $1.8 million [= ($0.30 x 12 million) / 2]. Triangle (D + E + F)'s height is $0.60 (= $1.80 - $1.20) and its base is 12 million so the initial producer surplus is $3.6 million [= ($0.60 x 12 million) / 2].

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f. The consumer surplus and producer surplus after the tax are the areas of triangles A and F in the graph. Triangle A's height is $0.20 (= $2.10 - $1.90) and its base is 8 million so the new consumer surplus is $800,000 [= ($0.20 x 8 million) / 2]. Triangle F's height is $0.40 (= $1.80 - $1.20) and its base is 8 million so the new producer surplus is $1.6 million [= ($0.40 x 8 million) / 2].g. The loss of consumer surplus is $1 million (= $1.8 million - $800,000) and the loss of producer surplus is $ 2 million (= $3.6 million - $1.6 million) so that the loss of welfare is greater for producers than for consumers.h. The deadweight loss of the tax is (C + E). Triangle C's height is $0.10 (= $1.90 - $1.80) and its base is 4 million shakes so its area is $200,000 [= ($0.10 x 4 million) / 2]. Triangle E's height is $0.20 (= $1.80 - $1.60) and base is 4 million kilograms so its area is $400,000 [= ($0.20 x 4 million) / 2]. The deadweight loss is the sum of these two amounts, or $600,000.

4. a.

 As shown in the graph, the shift from S0 to S1 causes the equilibrium price as seen by consumers to rise from P0 to P1. Meanwhile the price as seen by producers remains at P0. As a result consumers pay the entire excise tax (area A in the graph).

b. 

As shown in the graph, the shift from S0 to S1 causes the equilibrium price as seen by producers to fall from P0 to P1. Meanwhile the price as seen by consumers remains at P0. As a result producers pay the entire excise tax (area B in the graph).

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5. a.

b. The initial equilibrium price and quantity of $6 and 2 million kilograms are found at the intersection of D and S0 (point a in the graph).  c. After the $8 minimum price is imposed the new quantity demanded is 1 million kilograms and the new quantity supplied is 3 million kilograms. Unless the government imposes additional policies there is a potential surplus of 2 million (= 3 million - 1 million) kilograms as shown by the horizontal distance between points b and c in the graph.d. The consumer surplus and producer surplus before controls are the areas of triangles (A + B + C) and (D + E + F) in the graph. Triangle (A + B + C)'s height is $4 (= $10 - $6) and its base is 2 million kilograms so the initial consumer surplus is $4 million [= ($4 x 2 million) / 2]. Triangle (D + E + F) has the same height of $4 (= $6 - $2) and its base is 2 million kilograms so the initial producer surplus is also $4 million.e. The consumer surplus and producer surplus after controls are the areas A and (B + D + F) in the graph. Triangle A's height is $2 (= $10 - $8) and its base is 1 million units so the new consumer surplus is $1 million [= ($2 x 1 million) / 2]. Area (B + D + F) can be treated as the sum of areas (B + D) and F. Rectangle (B + D)'s height is $4 (= $8 - $4) and its width is 1 million kilograms so its area is $4 million (= $4 x 1 million). Triangle F's height is $2 (= $4 - $2) and its base is 1 million kilograms so its area is $1 million [= ($2 x 1 million) / 2]. The new producer surplus is the sum of these two amounts. This equals $5 million.f. Due to the combined polices, the consumer surplus falls from $4 million to $1 million and the producer surplus rises from $4 million to $5 million. Therefore consumers are made worse off and producers are made better off.g. The deadweight loss created by these combined policies is the area of triangle (C + E) in the graph, which can be treated as the sum of the two triangles C and E. Triangle C's height is $2 (= $8 - $6) and its base is 1 million kilograms so its area is $1 million [= ($2 x 1 million) / 2]. Triangle E has the same height of $2 and base of 1 million kilograms so its area is also $1 million. The deadweight loss is the sum of these two amounts. This equals $2 million.h. With S1 the surplus created by the policy increases to 3 million (= 4 million - 1 million) kilograms. This is shown by the distance between points b and d in the graph.

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6. a.

b. The initial equilibrium price and quantity of $600 and 4,000 units are found at the intersection of D0 and S (point a in the graph).c. The $400 price ceiling means a new quantity of 2,000 units and a shortage of 4,000 (= 2,000 - 6,000) units. This is shown by the difference in the horizontal distance between points b and c in the graph.d. The initial consumer surplus and producer surplus are the areas (A + B + C) and (D + E + F) in the graph. Triangle (A + B + C)'s height is $400 (= $1,000 - $600) and its base is 4,000 units so the initial consumer surplus is $800,000 [= ($400 x 4,000) / 2]. Triangle (D + E + F) has the same height of $400 (= $600 - $200) and its base is 4,000 units so the initial producer surplus is also $800,000.e. The new consumer surplus and producer surplus are the areas (A + B + D) and F in the graph. The first area can be treated as the sum of triangle A and rectangle (B + D). Triangle A's height is $200 (= $1,000 - $800) and its width is 2,000 units so its area is $200,000 [= ($200 x 2,000) / 2]. Rectangle (B + D)'s height is $400 (= $800 - $400) and its width is 2,000 units so its area is $800,000 (= $400 x $2,000). The new consumer surplus is the sum of these two amounts, equaling $1,000,000. Triangle F's height is $200 (= $400 - $200) and its base is 2,000 units so the new producer surplus is $200,000 [= ($200 x 2,000) / 2].f. Due to the controls the consumer surplus rises from $800,000 to $1,000,000 and the producer surplus falls from $800,000 to $200,000. Therefore tenants who are able to find units at the ceiling price are made better off and landlords are made worse off.g. The deadweight loss is the area of the triangle (C + E) in the graph. This can be treated as the sum of the triangles C and E. Triangle C's height is $200 (= $800 - $600) and its base is 2,000 units so its area is $200,000 [= ($200 x 2,000) / 2]. Triangle E has the same height of $200 and its base is 2,000 so its area is also $200,000. The deadweight loss is these two amounts combined. That equals $400,000.h. With D1, the shortage created by the policy increases to 6,000 (= 2,000 - 8,000), which is shown by the distance between points a and d in the graph.

7. a.

  1 2 3 4 5  (lowest)       (highest)

Country 1 [7] [11] [17] [24] [41]Country 2 [5] [10] [15] [25] [45]Country 3 [9] [14] [18] [23] [36]

For Country 1 the cumulative shares received by each group are 7%, 18% (= 7 + 11), 35% (= 18 + 17), 59% (= 35 + 24), and 100% (= 59 + 41). For Country 2 the shares are 5%, 15% (= 5 + 10), 30% (= 15 + 15), 55% (= 30 + 25), and 100% (= 55 + 45). For Country 3 they are 9%, 23% (= 9 + 14), 41% (= 23 + 18), 64% (= 41 + 23), and 100% (= 64 + 36).b.

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c. Country 3 has the most equal distribution of income because its Lorenz curve is closer to the 45-degree line in the graph than the curves for the other two countries. Country 2 has the most unequal distribution of income because its Lorenz curve is farther from the 45-degree line in the graph than the curves for the other two countries. The Lorenz curve for Country 1 is between those for the other two countries.

8. a. For income before transfer payments and personal income taxes the cumulative shares received by each group are 1%, 8% (= 1 + 7), 23% (= 8 + 15), 48% (= 33 + 25), and 100% (= 48 + 52).

For income after transfer payments and personal income taxes the shares are 5%, 16% (= 5 + 11), 32% (= 16 + 16), 56% (= 32 + 24), and 100% (= 56 + 44).

b. The Lorenz curve for income after transfer payments and taxes is significantly closer to the line of perfect equality (the straight diagonal in the graph), which shows that government intervention in the form of transfer payments and taxes has made the distribution of income more equal.

9. a. Because the Gini coefficient has risen, the distribution of Canadian pretax income has become more unequal.

b.

Order from: Country1. most equal France

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2 Germany3 Japan4 Canada5 Italy6 United Kingdom

7. least equal United States

Given that the country ranking is from most equal to least equal, the first-ranked country is the one with the lowest Gini coefficient (France) and the last-ranked country is the one with the highest coefficient (the United States).

10. (Essay) a. Governments would apply subsidies to products such as speed-limiting devices on cars, or certain types of building insulation, that lead to net reductions in emissions.b. If the introduction of carbon taxes were made revenue-neutral, for example through a decrease in income tax rates, then residents of large urban centres who bike or take rapid transit rather than owning a car would probably end up paying less tax than before. Similarly, those individuals able to work from home would probably pay less tax. On the other hand, most rural inhabitants, who tend to depend on cars for mobility, would likely pay. So would individuals whose careers involve a great deal of travel either by car or airplane.

11. (Essay) a. The spillover cost, which represents the costs to others if an individual consumes this item, is found by calculating the expected increase in taxpayer-financed healthcare costs caused by the consumption of this single serving.b. By vertically shifting the market supply curve, the excise tax would reduce the equilibrium quantity of french fries produced and sold. If the excise tax is set equal the per unit spillover cost, the market would reach quantity where the requirement of marginal cost pricing is met.c. First, the link between the consumption of food items such as french fries and healthcare costs is indirect, with only a minority of consumers creating the bulk of the costs. Other consumers of these items are therefore likely to oppose such a tax. Second, such a tax will have a disproportionate effect on low income consumers for whom the foods most likely to be taxed are often more accessible and affordable than healthier nutritional choices.

Advancing Economic Thought Problems

1. (Essay) a. Malthus predicted that limits on the amount of land that could be cultivated would eventually stall the growth in living standards in countries such as Great Britain as the geometric rate of population growth finally outstripped the algebraic growth of food.b. Malthus did not pay sufficient heed to the effects of technological change in allowing the growth in food production to outpace the growth in population. In fact, technological progress has allowed food prices to fall relative to other prices in industrialized economies. Population growth rates in industrialized countries have also dropped. This is due not only to more accessible methods of birth control but also because economic trends have made large families less attractive. With prohibitions against child labour and the introduction of old age security, children are now more likely to be seen as a form of consumption in modern industrial societies.

2. (Essay) As food becomes scarcer, its price will rise, creating an incentive for farmers to grow more food. Because the output of food is partly dependent on demand factors, the growth in food stocks cannot be viewed as being independent of population growth.

Simulations

Simulation 1

1. Introductory Information

Time:Approximately 20 minutes.

Materials:Photocopies of the three cases found below.

Case A (enough copies for half the class):  

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  - You are a landlord.  - You have been in business for 25 years.  - Rent controls have been imposed in your city.  - You cannot rent your apartments for any monthly price higher than $500, but you know that, because of the shortage of apartments, you can find many other prospective tenants willing to pay the controlled rent of $500.  - You do not have to disclose this information during your negotiations.

Case B (enough copies for one quarter of the class):    - You are a student looking for a new apartment.  - You have a part-time job and some student loans.  - This is not your favorite apartment or the best location.  - You estimate that the maximum monthly rent you can afford is $600, but that at any amount above $400 your budget is becoming stretched.  - You realize you are living in a city with rent controls.  - If you do not reach a deal for an apartment, you will be forced to move in with a high school friend, who, while eager to have you as a roommate, is untidy, financially undependable, and loves playing music at full volume at 2 am.  - You do not have to disclose this information during your negotiations.

Case C (enough copies for one quarter of the class):      - You are a student looking for a new apartment.  - You have a part-time job and some student loans.  - You estimate you can afford up to $800 per month in rent.  - You realize you are living in a city with rent controls.  - While your goal is to rent an apartment at a reasonable price, it is acceptable if you do not reach a deal with a landlord. Your parents live down the street and have offered you the option of living at home at a cost of $200 per month to help them cover expenses.  - You do not have to disclose this information during your negotiations.

Set-up:(1)  Place all students in pairs facing each other. One student will be a landlord and the other a tenant. (2)  The landlords will be given Case A.(3)  Half the tenants will be given Case B and the other half Case C. The students must not share the information provided in the cases with their partner they are negotiating with.(4)  Each pair will be given five minutes to reach a deal on the apartment rental.  If they reach a deal, the landlord and tenant write a statement (the rental contract) of the agreed-upon monthly rent.

Key Concepts Covered:price ceilingprice elasticity of demandshortage

Learning Objectives: - Draw and discuss the market demand and market supply curves for apartments. - Evaluate the effects of the shortage created by rent controls as an example of a price ceiling, based on hands-on experience with negotiations for apartments. - Explain some of the factors that affect price elasticity of demand. 

2. Exercise

Recall that the class has been divided evenly into pairs.   In each pair, one student will be a landlord and the other a tenant.

Students as landlords: The landlords will be given Case A. 

Students as tenants: Half the tenants will be given Case B and the other half Case C. The students must not share the information provided in the cases with their partner they are negotiating with.  Timekeeper: students will be given 5 minutes to negotiate. Sit facing your partner and begin negotiations by making an opening offer.

Procedure: If not already done, students acting as landlords will be given Case A. Half the tenants will be given Case B and the other half Case C. Sit facing your partner and once time starts, begin negotiations by making an opening offer. You are not

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allowed to share the information with your partner during the case. If they reach a deal, the landlord and tenant write a statement (the rental contract) of the agreed-upon monthly rent.

A student with Case B may choose not to sign a rental agreement with the landlord because of budget constraints.

And a student with Case C may choose not to reach a deal with the landlord because of available substitutes.

Assuming the rent controls cause an apartment shortage, students with Case B are made worse off by the controls.  Explanation:

Many of the students with Case B, and some with Case C, will have not reached a deal with their landlords. Those with Case B can cite the budget constraints they face. Those with Case C can cite the option to stay with their parents at a low monthly cost. Many of the tenants with less attractive options (i.e. with Case B) were the ones most harmed by the apartment shortage (landlords with many potential tenants may choose not to enter agreements with renters with situations like case B).

Follow-up areas of learning:

 - Discuss the impact of the access to substitutes and the status of an apartment as a luxury as opposed to a necessity, in the case of students with Case C, on the price elasticity of demand. - Discuss the potential inequities of the shortage that results from a price ceiling such as rent controls. While some of the students who have not reached a deal with their landlords will be able to reach an agreement with other landlords, others will not.

3. Discussion Questions (essay)

Note that this question will be manually graded by your instructor.

1. a. Show a shortage of apartments in a market with rent controls in the demand and supply graph below. Use the double headed arrow tool to show a shortage.  

[instructor-marked graph]

 b. Refer to the simulation to explain how the effects of the shortage created by this price ceiling can be inequitable for tenants.

Only the tenants with more attractive options (i.e. with Case C) were harmed by the apartment shortage.Only the tenants with less attractive options (i.e. with Case B) were harmed by the apartment shortage.Many of the tenants with less attractive options (i.e. with Case B) were the ones most harmed by the apartment shortage.*Many of the tenants with more attractive options (i.e. with Case C) were the ones most harmed by the apartment shortage

2. a. How would you classify a product such as a rented apartment? 

An apartment is always a necessity.An apartment is a luxury for those with no other options but a necessity for those with alternatives.For a student, a private apartment is always a luxury.An apartment is a necessity for those with no other options but a luxury for those with alternatives.*

b. What impact does this have on the price elasticity of demand? Use an example from the exercise.

The price elasticity of demand is less for those students who have alternative optionsThe price elasticity of demand is greater for those students who have alternative options.*

3. What is the current situation regarding rent controls in your city? What is the vacancy rate? Describe the real market for apartments in your city. [instructor-marked answer box]

Explanation:

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1. a. See solution graph above. A shortage is shown with a price below equilibrium where the demand curve lies to the right of the supply curve. Because the controlled price is below equilibrium, the size of the gap between demand and supply is the value of the shortage at that price.

    b. Many of the tenants with less attractive options (i.e. with Case B) were the ones most harmed by the apartment shortage. But those tenants, with Case B, who can obtain a rent controlled apartment are made better off by rent controls. 

2. a. An apartment is a necessity for those students with no other options and a luxury for those who could live with their parents.

    b. The price elasticity of demand is greater for those students who have the option of living with their parents.

3. The answer will depend on your city. British Columbia has rent controls. Ontario has more complicated rent control rules that depend on a number of factors like the age of the property. Students from other countries may share their knowledge of the situation in other national contexts.

And many of those who do not manage to rent an apartment will be those with less attractive options (i.e. those with Case B).

4. Multiple Choice Questions

1. When the government imposes rent controls, it creates a shortage.

surplus.shortage.*rightward shift in supplyrightward shift in demandleftward shift in demand

2. The following factor(s) have an effect on a product's price elasticity of demand:

access to substitutes for the product.the amount of time households have to change their buying habits.the portion of income represented by expenditure on the product.whether the product is a necessity or a luxury.all of the above.*

3. If you have the option to live at a low monthly cost in your parents' house, then as a prospective tenant you:

have access to a complementary product.consider renting an apartment to be a necessity.would have a more inelastic demand curve than someone who did not have this optionhave access to a substitute product.*gain more utility from renting an apartment than would someone without this option

4. In the long run, the greater ability of landlords to adjust their quantity supplied of apartments would cause the supply curve to

be more elastic.*be more inelastic.shift to the right.shift to the left.remain unchanged.

5. In the long run, the greater ability of tenants to adjust their quantity demanded of apartments would cause the demand curve to

be more elastic.*be more inelastic.shift to the right.shift to the left.remain unchanged. Explanation:

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1. When the government imposes rent controls these are set below what would otherwise be the equilibrium rent. With this lower price the quantity demanded is higher and the quantity supplied is lower than it would be at equilibrium. Therefore it creates a shortage.

2. The following factor(s) have an effect on a product's price elasticity of demand. All of the options: the portion of income represented by expenditure on the product; access to substitutes for the product; whether the product is a necessity or a luxury; the amount of time households have to change their buying habits.

3. If you are a prospective tenant the option of living at a low monthly cost in your parents' house represents access to a substitute product.

4. In the long run, the greater ability of landlords to adjust their quantity supplied of apartments would cause the supply curve to be more elastic, with a given change in price leading to a larger change in quantity supplied.

5. In the long run, the greater ability of tenants to adjust their quantity demanded of apartments would cause the demand curve to be more elastic, with a given change in price leading to a larger change in quantity demanded.

Simulation 2

1. Introductory Information

Time:Approximately 30 minutes.

Materials:No Materials are necessary.

Set-up:Divide the class into groups of four students. In each group two students will represent “Further Education” and the other two will represent “Working Immediately.” The students should be seated in pairs facing each other.Following the debate, the instructor will bring all of the ideas together for a full class discussion of the arguments presented in the debate.

Key Concepts Covered:human capitaljob discriminationlabour productivityseniority rightswealth

Learning Objectives:Illustrate and discuss the reasons for income inequality in society and the impact it has on the career decisions we make in our lives.Explain and evaluate the decision to pursue postsecondary education based on the concept of human capital.Demonstrate an understanding of the impact on income distribution of such factors as labour productivity, job discrimination, seniority rights and wealth.

2. Exercise (essay)

Recall that students are in groups of four, seated in pairs facing each other. From each group, two students will represent “Further Education” and the other two students will represent “Working Immediately.”  Timekeeper: Each pair will be given ten minutes to prepare their arguments and, following that, ten minutes to debate the topic. 

Stage 1: Each pair of students will be given ten minutes to find their own space, away from the rest of their group, in order to prepare their case.  After the ten minutes, the students will return to their positions.

The students will be given ten minutes to debate the topic, “It is economically beneficial to pursue a postsecondary education?” in

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their groups of four. During the debate the students should be keeping notes of the arguments

Stage 2: Following the debates the instructor will create a list of the pros and cons for postsecondary education on the board. This will give each pair an opportunity to share their arguments with the rest of the class. 

Students should address issues such as opportunity cost, income distribution and the number of people with postsecondary education. The instructor can also encourage students to analyze the independent roles played by such factors as ability, experience, seniority rights, job conditions, discrimination, risk-taking, regional disparities, trade unions, and wealth.

Write a short essay that outlines the specific reasons that were most important to you when you made the decision to pursue a postsecondary education.

Select a country for which you can find education statistics. Summarize the statistics below.

Briefly discuss the connection between average household income and education. Explanation:

Reasons may include desire for knowledge, family pressure, future earning potential, etc.

Depends on the country chosen.

Income and education are generally positively or directly related.  

Follow-up areas of learning:

Analyze the independent roles played by such factors as ability, experience, seniority rights, job conditions, discrimination, risk-taking, regional disparities, trade unions, and wealth as they relate to education and employment.

3. Discussion Questions (essay)

1. Describe the impact that education has had on your career path so far. How has it affected the type of job you are in? What impact has it had on wages?

2. Describe a time when your attitude towards risk taking has affected your earnings. 

Explanation:

1. & 2. Answers will vary depending on the student's own participation in the labour market.

4. Multiple Choice Questions

1. One of the main advantages of pursuing a postsecondary education is that it:

has an opportunity cost in terms of the direct and indirect costs of pursuing an education.is an investment in human capital which can lead to higher incomes in the future.*makes it easier to claim seniority rights later in one's career.makes one likelier to take on jobs that have unstable incomes.all of the above

2. Typically with more education your income will

rise.*fall.stay the same.fall unless you are below the poverty line, in which case it will rise.rise unless you are below the poverty line, in which case it will stay the same.

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3. All of the following are reasons for income inequality, except:

job conditions.labour productivity.experience.family size.*education.

4. Workers in the same occupation can earn a different amount of money because of:

discrimination.their seniority.the region they work in.whether or not they are part of a union that represents at least some workers in the occupation.all of the above.* Explanation:

1. One of the main advantages of pursuing a postsecondary education is that it is an investment in human capital which can lead to higher incomes in the future.

2. Typically with more education your income will rise.

3. Family size is not a reason for income inequality. 

4. Workers in the same occupation can earn a different amount of money because of: their seniority, the region they work in, whether or not they are part of a union that represents at least some workers in the occupation, and discrimination.

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