• January 29th, 2016

Economics

Paper, Order, or Assignment Requirements

You may also want to make a copy for yourself to study from the test that takes place at the next meeting.)

1a.  Consider the market for beef shown in the graph below.

1a.  What is the equilibrium price and quantity of beef in this market?

1b.   Suppose the government is considering imposing a price ceiling of $5 on beef.  How much beef will be exchanged if the law is strictly enforced?

1c.  As a result of the policy, how much wealth was transferred from beef producers to beef consumers?  Shade the rectangle on the graph.

1d.  As a result of the policy, what was the deadweight loss associated with the sales that were prevented by the regulation?

1e.   Assume that chicken is a substitute for beef and its price is not regulated.  Draw the supply and demand curve for chicken before the price ceiling was imposed on the beef market and label your equilibrium point “a”.  Then add a new demand curve to show what happens afterward and label your new equilibrium point “b”.

1f.  Based on your diagram, would you expect chicken producers to support the regulation in the beef market?  Why?

 

2a.  Bob enjoys eating donuts and drinking coffee.  In fact, that’s all he does.  His weekly budget is $100 and the price of donuts is $1 per can and the price of coffee is $2 each.   Using the vertical axis for his coffee consumption and the horizontal axis for his donut consumption, draw his budget constraint.

2b.  Add a plausible indifference curve to your diagram that shows Bob’s optimal quantity of donuts and coffee.   What is his marginal rate of substitution of donuts for coffee at that point?

 

2c.  Suppose that the government, in an effort to reduce obesity, places a tax of $1 on donuts.  Sketch Bob’s new budget constraint.

 

2d.   How does the price regulation affect Bob’s total utility?  How does it affect his donut consumption?

 

  1. Read the information about U.S. Import Quotas and then analyze the policy by answering the questions which follow.

Every year U. S. consumers pay from $500 million to $3 billion extra for sugar and products containing sugar because the U.S. government imposes import quotas and provides subsidies for sugar beet and sugar cane farmers.  True, even at $3 billion, this works out to only around $10/consumer, but what about the other side of the fence? Sugar trade policies allow approximately 10,000 growers to each reap anywhere from $40,000 to $250,000 annually, with a relatively few larger growers receiving the greatest benefits.  How did cane and beet farmers get this sweet deal?

A look at the history of the American sugar industry reveals that government involvement in the sugar market is anything but new.  In 1789, the First Congress of the United States imposed a tariff on foreign sugar.  Its simple purpose – to raise revenue – proved to be a sweet deal for a government that had no income tax with which to pay its expenses. Although the purposes varied and the legislation became more complex, the federal government’s sweet tooth was in evidence throughout the next century.  Between 1789 and 1930, Congress enacted a total of 30 pieces of sugar tariff legislation.

In the 1930s the focus of sugar policy changed from raising revenue to protecting sugar growers from foreign competition, and the 1934 Jones-Costigan Act initiated the use of quotas to control the supply of sugar in the U.S. market.  Under that legislation, the Department of Agriculture determined the demand for sugar; that is, it made an educated guess about how much sugar people and businesses would buy.  The next step was to choose who would supply the sugar to meet this estimated demand. The USDA allocated just over 99% of the supply quota to:

  1. S. suppliers of beet and cane sugar, and
  2. Cane sugar suppliers from Cuba and the U.S. dependencies of Hawaii, Puerto Rico, the Virgin Islands, and the Philippines.

Once the domestic supply was allotted, the quota for imported sugar was determined by subtracting the amount produced by groups 1 and 2 from the total estimated demand.  Thus, foreign producers were allowed to supply less than 1% of the sugar that American consumers wanted.

In the late 1940s, the U.S. started using sugar quotas as a foreign policy tool.  For example, Cuba received preferential treatment in the assignment of 1948 quotas because Cuban cane growers had increased output during WWII and supplied the U.S. with low-priced sugar.  Ironically, in 1960 the sugar quota was once again used as a foreign policy tool in Cuba, but this time all sugar imports were banned to protest the communist takeover of Cuba’s government.

Beginning in 1970, world consumption of sugar increased significantly and resulted in record high world sugar prices. Because of these high prices, the U.S. government removed the quotas on raw sugar and the Agriculture Department stopped allocating sugar quotas for domestic areas.  Only a small tariff remained on imported sugar.

Predictably, the high world price called out increased production by both domestic and foreign producers and the price declined sharply. In response to this decline the U.S. government increased the tariff on imports and instituted subsidies for domestic growers through a loan guarantee program.  Growers are allowed to obtain government financing at a below-market rate and commit raw sugar as collateral. If the market price does not reach the level of the loan rate the producer simply gives the collateral sugar to the government to repay the loan.  Definitely a sweet deal for sugar farmers.

When the world price of sugar continued to fall, the U.S. re-imposed the sugar quota in 1982.  The quota worked as expected, reducing the amount of sugar available to purchase and thus pushing the price higher.  Since that time the U.S. has continued to use quotas to regulate the volume of raw sugar imports so that domestic sugar prices don’t fall below the MSP.  If the volume of sugar on the domestic market increases – say, because of an extraordinarily good crop year – the import quota is reduced.  If domestic production is very low for some reason, then the import quota may be expanded.

3a.  What is the rationale for this policy?  Choose from:

  1. Paternalism B.  Macro-stability       C.  Correct Market Failure   D.  Promote Equality      E.  Win Votes

3b.  Trace the effects of this policy by sketching supply and demand diagrams for sugar and for corn syrup (a substitute for sugar).   Start with a “competitive equiliblium” and then show what happens when the policy of sugar quotas is introduced.

 

3c.  Evaluate the sugar quota in terms of 3 types of efficiency:

  • in the product mix. Is this combination of sugar and corn syrup preferred by consumers?  If there is a deadweight loss, show it on your supply and demand diagrams.

 

 

  • In distribution. There is less sugar, but is it being rationed to those who value it most?

 

 

  • In production. There is less sugar, but are producers minimizing their costs?

 

3d.  Evaluate the sugar quota in terms of two types of equality:

  • Vertical: Are the poor disproportionately affected by the rising food prices?  Explain

 

  • Horizontal: Does the policy increase discrimination based on superficial differences or personal preferences?      (Hint:  if you like candy, does the policy have a disproportionate effect on you?)

 

3e.  Explain the politics behind the policy.

  • Is this an example of government failure? What type?

 

  • How are the costs and benefits of the policy distributed? Does this explain why politicians support it?

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