S.
Klepper, Economics
73-100, Fall 2009
Solution to Quiz 5
The
subsidy reduces the effective price of new homes to buyers. For example, suppose that before the subsidy
the demand curve for new homes was such that at a price of $100,000 per home a
total of 10,000 homes were demanded and at a price of $80,000 per home a total
of 15,000 homes were demanded. If the
government then pays 20% of the price of new homes and the price charged by
sellers was $100,000, then the effective price of a new home to buyers would be
$80,000. At this price, buyers would
demand 15,000 new homes. So under the
subsidy program, the quantity demanded at a price charged by sellers of
$100,000 would be 15,000 new homes versus 10,000 new homes prior to the
subsidy. More generally, the quantity
demanded at each price charged by sellers will increase, causing the market
demand curve to shift to the right. This
is pictured in the figure below by the shift in the market demand curve from D0
to D1.
Initially,
the equilibrium price and output are P0 and Q0
respectively. The subsidy has no effect
on the costs of suppliers. Consequently,
it causes only the market demand curve to shift. The new equilibrium price and output are P1
and Q1 respectively, both of which are higher than the original
equilibrium price and output. Since both
price and output rise, sellers increase their total revenues.
Based on this description, the answers to the individual questions are:
_____1.
True
_____2. False
_____3.
True
_____4. True
_____5. True