Price Controls and Price Elasticity of Demand

1. To encourage increased growth of grasslands in the Animal Kingdom, their leader, Simba, is considering a subsidy for production of grasslands. Suppose that the market for grasslands can be represented by the following equations:

Demand: P = 200 – 1.5Q
Supply: P = 50 + Q

where P is the price per acre, and Q represents quantity of grasslands, represented in acres consumed per week.

a) Calculate the equilibrium price and quantity of grasslands before the subsidy.
b) To encourage grassland production, Simba announces a price floor of $140 per acre. With this new price floor, what will be the new quantity of grassland consumed in the Animal Kingdom?
c) Illustrate your answers to (a) and (b) on a graph. Using this graph, calculate the consumer surplus and producer surplus at the initial equilibrium price and quantity from part (a).
d) Calculate the new consumer surplus and producer surplus with the price floor of $140 per acre (part b).
e) How does the total consumer and producer surplus in part (c) compare to the total consumer and producer surplus in part (d)? What explains the difference in these two figures?
f) Suppose that the government supports the $140 per acre price by purchasing any excess grassland that producers make available, but are unable to sell to other animals. How many acres of grassland must the government buy?

2. The Department of Housing and Urban Development (HUD) has used housing subsidies as one of its principal tools for guaranteeing adequate housing for low-income families. An economist at HUD estimates that a 20 percent drop in the price of housing will stimulate an increase in demand for low-cost housing approximately by 13.5 percent in 2003. With this information, calculate the price elasticity for low-cost housing, and interpret this number for a non-economist.
Suppose the President has set a target of increasing low-cost housing consumption by 35 percent (compared to 10 million). Based on the price elasticity you calculated above, what percent drop in price is required to meet this goal?

a) Calculate the equilibrium price and quantity of grasslands before the subsidy.


Demand = 200-1.5Q =50 +Q =Supply
200-50=Q+1.5Q
150=2.5Q

Q=150/2.5 = 60
P =50+60= $110...

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