S. Klepper, Economics 73-100, Fall 2011

Solution to Mini-test 5

If the government builds one million new homes, it will have no effect on the market demand curve. It will also not affect the marginal cost curve of private producers of new homes, and therefore private producers will continue to supply the same number of new homes at each price in the short run. With the addition of one million new homes which the government is willing to sell at the going price, the total quantity supplied (by private producers and the government) will increase by one million at every price. This is pictured in the figure below by the shift in the supply curve from S₀ to S₁. The shift in the supply curve causes the price of new homes to decline from p₀ to p₁ and the quantity of new homes sold to increase from q₀ to q₁. The decrease in price reduces the quantity of new homes supplied by private producers. Thus, private producers sell less new homes, so that the net increase in the number of new homes sold is less than the additional one million homes supplied by the government. There is an increase in the number of new homes sold, though, which implies that private producers decrease their sales by less than the one million new homes offered by the government.

Based on this description, the answers to the individual questions are:

_____1. False

_____2. False

_____3. True

_____4. True

_____5. False