Module 5

But first… answers to the worksheet questions from the last module…

1. Indicate how demand (D), supply (S), price (P), and equilibrium quantity exchanged (Q) are
affected after taking into account all the events given. Assume all events have an impact on the
market being considered.

Price
S
Market Event(s) D S P Q
Video Technological advances
Cassettes reduce the cost of DVD D
Recorders players (a substitute
(VCRs) good). (D falls) - 0 - -
Public expects a future
in which movies can be Q
downloaded directly
onto computers from the
internet. (D falls)

Price
Fast food Public becomes S
concerned over high
sodium and cholesterol - - ? - D
(D falls); there is an
increase in the wage
paid to fast food
Q
employees (S falls)
Price

Bicycles Public becomes S

increasingly concerned
about physical fitness (D
rises); lots of bikers get ? 0 ? ?
hit by cars. (D falls) D

Q
Now onto Module 5…

Excise Taxes
An excise tax is a tax placed on a single item – like gas – as opposed to a
broad range of items – like a general sales tax. Excise taxes can be seen
either as a supply curve shift (“placed on the seller/producer”) or a demand
curve shift (“placed on the buyer”). In the end it makes no difference…
you get the same result whether the tax is placed on the buyer or the seller.
The burden of the tax is going to be shared between the producer and the
consumer regardless of where it is placed. This is something you will
probably do in intermediate Micro … so let’s make our lives easy and keep
our analysis limited to an excise tax on suppliers only. So on tests (such as
the final) you will only have to demonstrate and/or interpret a tax placed
on the producer (shifting the supply curve) – just as in your book.
Once we implement a tax there is a divergence between the price the consumers pay and the price the
producers get (with the difference being the tax). Let’s let Pc = price consumers pay (including the
tax), Pp = price producers receive (after giving the tax to the government), and t = tax. Or…Pc = Pp + t

Consider the S&D for 7-up prior to a tax. Equilibrium is where S and D intersect.

Price Supply Demand St

8 70 10 P
S
7 60 20 $6
6 50 30
5 40 40 Pc=$5.50
4 30 50
3 20 60 $5

Pp=$4.50
Now consider a $1 per unit tax placed on
producers/sellers (from now on I am just going
to call these guys producers). When the D
producer sells the 7-up to you she is then required
to turn around and give $1 to the government. Q
35
40
At first thought you might say… well, she is just going to increase the price by $1, so, in fact, I am
paying it. That turns out to be partly right. She would love to pass the entire tax of $1 on to you. If she
sells the product at $6 instead of $5 then, after paying the $1 tax to the government, she would be just
as well off as before the tax. Unfortunately, for her, things won’t work out quite this way.

Think of the tax as another cost of production. Like other costs it forces producers to charge a higher
price at any given output level. We incorporate the tax into the S&D framework by shifting the S
curve vertically up by exactly the amount of the tax. St is exactly “t” above the original S curve.

Our pretax equilibrium was $5 and 40 units exchanged. Now check out what happens in the graph
above if the price you pay is raised from $5 to $6 (that is, the producer tries to force all the tax on
you). Can the producer still sell 40 units?

No. At $6 there is excess supply. As the price rises we respond by drinking Mt. Dew.

So although the producer would love to force you to pay the full tax they, in fact,
cannot make you pay it. You may not buy the product at all!!! Thus, in the end the
price will fall below $6 and quantity demanded will fall below the original level.

Again, there is a divergence between what consumers pay (Pc = $5.50 in this case) and
what producers get (Pp = $4.50 in this case). The difference is the $1tax.

So in this case, relative to the “no tax” scenario, the consumers are bearing 50% of the tax burden and
producers are bearing 50% of the tax burden. That is, 50¢ of the $1 tax gets passed onto consumers
and 50¢ of it results from reduced revenue for producers.

Below I expand on the price floor and price ceiling discussion. I will repeat some things in the book.
This is an important discussion as it illustrates why economists tend to be so pro-market. Let me start
with the conclusion: economists don’t like these interventions – not because they are opposed to the
goals but because they lead to unintended consequences.

Mess with the market and the market will mess with you – Part I: Price ceilings

Effective price ceilings lie below the intersection of S&D… this sometimes confuses
students because it seems like a “ceiling” should be above everything. But the
purpose of a price ceiling is to prevent the price from rising above a certain
(arbitrary) level. Look at a S&D diagram and imagine the price beginning at $0
and moving up the y-axis (the price axis). With no price ceiling, the price would
rise until the S&D curves intersect… and it would stop there. That would be the
market price. Now do the same thing but put in a price ceiling. If it is below the S&D intersection then
price hits the ceiling and stops… it cannot legally go any higher. That is the whole point of it.

If your price ceiling is above the S&D intersection it would not be an effective price ceiling and would
have absolutely no impact on the market. Why not? (Answer
before reading on)
S
Answer: Because, as you increase price (up the y-axis) the
price would stop at the intersection of the S&D curves. Your
price ceiling is there but it is not doing anything – but it
could become effective in the future if something were to $5
cause the price to rise.

So let’s do an example. Perhaps you believe that $2

milk should be accessible to all individuals but it D
is $5 per gallon. So you impose a price ceiling at
$2 / gallon to keep it affordable. Here is a short list
of some problems you will create: Qs Qd
Excess demand
- Excess demand: at cheaper price consumers have more
incentive to consume and producers have less incentive to produce. You can see this in the graph.
- Allocation problems: in a free market goods are allocated by price. Anyone willing and able to
purchase the good can purchase the good. But now we are no longer using price to allocate the
good… so the question becomes… who are the lucky ones that get the milk? Normally the good
will be allocated by standing in line… first-come first-served. You still pay a price – but it is in
terms of time as opposed to money. Note that the rich will still get the good as they can pay
someone to stand in line for them. Other allocation methods might be coupons, random lottery or
the following two items listed here…
- Black (illegal) markets: the law is preventing willing buyers and sellers from making trades – so
there is a freedom argument that can be made against this policy. Why is the government
preventing willing participants from making trades? People might begin to make trades away from
the eyes of the government. This enables mafia type organizations to gain power by controlling the
markets. Why do Mexican drug gangs fight over cocaine but not tequila?
- Corruption: political connections become very helpful. Politicians can use this power not only to
acquire the goods for themselves and their friends – but also to sell in the black market.
- Policing costs: the government will need to expend resources to combat black markets. These
resources (including labor hours of policemen) have opportunity costs. Of course if government
 officials are benefitting from the law (see corruption above) they still have incentive to crack down
on their black market competitors.
- Decline in quality: producers have incentive to cut costs… why not since they are getting less for
their product now…they might add water to the milk. 1 If some consumers don’t like it … fine…
after all, there is excess demand.
- Targeting: presumably these policies are intended to especially help the poor… but are we helping
them? Price ceilings affect everyone. In fact, as noted above the well-connected rich will probably
end up getting the good more than the poor anyway.
- Inflexibility: Once a ceiling is set it takes another act of government to change it. Governments
tend to be slow in reacting to change.
- Lack of transparency: When making cost-benefit decisions you are always better off having a
clear idea of the costs and benefits. The costs of price controls (listed above) are hard to assess.
They are there but they come out in weird and unexpected ways… so it is difficult to judge the
impacts of the policy.

If the problems of price ceilings are not clear yet then how about this: if $2 per gallon of milk is good
then why not make it $1 per gallon? … that should be great! Heck, make it free!!! What would happen
if the government tried to force free milk onto society – would this be great?

Economists generally argue against price control policies because prices send signals.
Prices are messengers. If the price of something rises it is because there is higher demand
relative to supply. Forcing the price down by law will not resolve that fact – in fact, it will
make the situation worse because there is now a disincentive to produce on the supply side
and less incentive to conserve on the demand side. Price controls kill the messenger.2

Gas prices were temporarily capped during the 1970s oil shocks. The results were predictable. Ask
your parents about it and let your classmates hear what they say in a forum. If the Organization of
Petroleum Exporting Countries (OPEC) effectively cuts the supply of oil on world markets, or if
hurricane Katrina destroys oil refineries, or if terrorists threaten oil supplies – then there will be a rise
in gas prices due to, in all these cases, a leftward shift of the supply curve. Is this good? Well, yes…
given the fall in supply it is exactly what we want. Higher prices give consumers
incentive to conserve – look at our choice of cars to drive. Fuel-efficient Japanese
cars gained rapid market share in the late 1970s when gas prices had risen.
By the 1990s, when gas was as cheap as it has ever been (after
accounting for inflation)… the US started driving around in gas-
guzzling SUVs and Hummers. Then when gas prices shot up in the early
2000s suddenly Hummers were not so cool… and it was all about hybrids
(again, the Japanese car companies were way ahead of the US… but that is another
story…). A rise in gas prices gives gas producers incentive to invest in production of gas and car
producers incentive to invest in hybrids. We respond to prices. Block the price rise and you block the
message.

1
I used this example in class and a student that grew up in the USSR raised his hand and said that is exactly what milk
producers used to do there.
2
There is, in fact, an economic argument for price ceilings when there is a severe lack of competition. We can not illustrate
this until we discuss monopoly.
 Rent control is a price ceiling on rents designed to provide affordable housing for the
poor. Affordable housing is a great goal. Economists are not against that, they are just
against this particular method of trying to achieve the goal because it results in some
version of all of the costs we had in our milk example. Often there is an alternative
policy that can get you there with less distortion. Like what?

Well… economists have a simple method of getting more to the poor while limiting
markets distortions: give money to the poor - perhaps as a housing voucher if you
want to ensure that it be spent on housing. This increases demand directly.

The Department of Housing and Urban Development’s Section 8 Housing Voucher program is an
example. It is not problem-free. For one thing there has been fraud as people lie in order to qualify for
the government subsidy. But, on the whole, there are several advantages relative to rent control:

1. Targeting (helping those we want to help): When you actually look at who lives in rent-controlled
apartments you see a cross-section of society. Some tenants are wealthy, many are middle-class,
and some are poor. Rent-control especially benefits the random set of tenants that happen to be in
apartments when rent-control is implemented. Even if you need to be “poor” to qualify you are
usually allowed to stay as long as you want. So people tend to stay even if they eventually get
good jobs. If you are a landlord and a rent-controlled apartment becomes vacant you will have
dozens of people applying to live there (this is the excess demand). Who are you going to choose –
the wealthy guy that has a job at Intel or the poor guy that has a part-time job at 7-11? I have
friends in rent-controlled apartments who are definitely not poor. Why are we subsidizing these
lucky guys? If we subsidize, we should subsidize the poor. S
P

Housing voucher programs do a much better job of this (fraud aside).

They are provided through tax returns – so can be directly tied to income $

and number of dependents. In the S&D graph (to the right) I have shifted
the demand curve to the right to reflect the increased income given to
those that qualify for vouchers. Note this does put upward pressure on
rents… but there is no free lunch. That happens because we have D

directly increased the purchasing power of the poor. Qs Qd

Q

2. Incentive to build more rental housing units: Rather than put into place a disincentive to build
(as we get with rent-control) this policy, by stimulating demand, encourages supply.

3. Avoids black markets, policing costs, tenant-landlord litigation, quality problems…

- Rent control programs will create more landlord-tenant conflicts since landlords clearly have
incentive to reduce maintenance costs (as rents are being artificially forced down).
- Sometimes the landlord even has incentive to get the tenants out as that is the time that
he/she can raise the rent to market value. Crazy incentive to have in place.
- Conflict requires the creation of tenant-right groups and invariably increases litigation. So
lawyers win (at the expense of tenants and landlords).
- In New York it is not uncommon to have to pay “key money” in order to move into an
apartment – a one-time non-refundable payment to the owner. It is not “rent” so it gets
around the law… but it sure looks a lot like rent. (Seinfeld fans might recall when Elaine had
 to come up with $5,000 – then $10,000 - in order just to move into Jerry’s building.) Key
money is just a way around the law and clearly is a barrier for low-income
families.
- Lucky tenants that want to move out will have incentive to illegally sublet
their apartments to friends. For example, if I have a rent-controlled
apartment for which I pay $600 per month… I could move out and let
YOU move in without telling the landlord. Then I can charge you some
sum less than the true market value ($700?).

4. Transparency (clear costs and benefits): The cost of a housing voucher

program is very clear: $14.8 billion was spent in 2005 on Sect. 8 housing vouchers. We also know
exactly how many low-income families were helped (2.1 million). Now… should we expand it or
contract it? Have your argument – but at least the costs and benefits are clear.

Politicians love rent control because there are no budgetary costs – no need to raise tax revenues to
pay for it. It is “free” to implement. But there are, of course, costs… they just come out in weird
ways – like a declining and shrinking housing stock, less rental income for landlords, lower
quality, more lawsuits, etc... Rent control costs are difficult to measure.

5. Sharing the burden. Presumably providing affordable housing is a goal of all society. Rent
control takes a social goal and forces one group, landlords, to pay most of the costs. Why are we
making landlords pay for societies’ goals? Why not make dentists pay? Providing rental income
through a voucher program is paid for through taxes. All of society contributes – as it should -
since, again, this is a goal of society (not a goal of landlords or dentists).

Have had good/bad experience with rent control? Tell your classmates about it!!
Another policy economists would favor over rent control would be to P S

subsidize construction of affordable housing.

The government says to developers… “Look, if you build
$5000
housing of a certain density we will give you a tax break,
or we’ll chip in some of the building costs.”

This increases the supply of affordable housing 

It is transparent (the costs can be clearly measured), D
well-targeted, and is paid for, again, by all of society (through tax).
Qs Qd
Q
The difference between rent control and these policies is that these policies work with supply and
demand… not against them. They are not fighting the powerful forces of the market. Rather they use
them to achieve the goal.

Mess with the market and the market will mess with you – Part II: Price floors

Price floors attempt to do the opposite of price ceilings. They are an attempt to keep
prices above the equilibrium price. Why would we want to do that? Well… the
special interest group is different than the one that wants price ceilings. Ceilings are
intended to help consumers by keeping prices low. Floors are intended to help
producers by keeping prices high. So while producers will not be happy with price
ceilings… they love price floors. If they can bend the political process their way they
most certainly will.
An effective price floor must be set above the equilibrium price. We have two good examples of price
floors in our economy: minimum wages and agricultural farm support programs. I am going to discuss
farm supports in this chapter and leave a similar discussion of the minimum wage until the end of the
course when we talk about income inequality and poverty.

Farm support programs began in the 1930s when rural areas were hit hard in the Great Depression and
25% of the US lived on farms. So the idea is to help the hardworking family farm. The Great
Depression ended … but farm supports stayed. Consider a free market price of milk of $1 per gallon.
Dairy farmers scream, “Hey, how are we expected to make a living when the price of milk is $1? Have
you ever been on a farm? It is hard work! You have to help us… how about ensure that milk does not
sell for less than $4 per gallon? That would be nice.”

Congress obliges. Let’s consider the efficiency of this idea S

$4
The fundamental problem revolves around the resulting
excess supply: If you are studying along the way then the
excess supply will quickly jump out at you when you $1
consider this policy. This policy induces resources into milk
production. Suddenly milk farmers have more incentive to
raise cows and produce milk… and the quantity of milk
$0.5
supplied grows. Obviously the higher the floor price the D
more resources you induce into production. If you make it
high enough you might find farmers building heated barns in
Qd Qs
Maine in order produce milk. The problem is that these
resources have opportunity costs – they could go toward Excess supply
producing something else. And the more milk we have the
less we value it on the margin. Notice in the graph above that the value of the milk at Qs (the quantity
supplied given the price floor) will be much less than $4… I have indicated it as $0.50. That is what
consumers are willing to pay for the last gallon of milk – indicating a huge waste of resources (we
expend $4 on something we value at $0.50).

Consumers also respond to the floor. As the price gets forced up we want to buy less milk (Qd in the
graph above). So a big question becomes, who buys this excess supply?

The answer is the government. They must buy it up or somehow prevent it from emerging. Let’s say
they buy it. The question then becomes, what do they do with it? They cannot simply sell it to
consumers - we are already buying all the milk we want at $4. Other options include:

- Throw it away. Yep, take it out to the ocean and dump it. We have done this. It is not good
public relations so the government tries to avoid this.
- Save it up. We have huge silos filled with wheat, corn, dehydrated milk and other crops for
which we have price supports. Eventually it goes bad and is thrown out… it is a little more
politically acceptable to discard rotten food than fresh food.
- Use it for the military, school lunches. This seems like a relatively good idea… but note
that the government could have paid for the milk at a much lower price for taxpayers without
the price supports. They may also convert it to cheese or something and do the same. Again,
the taxpayer is paying a needlessly high price for these inputs.
 - Let the price to consumers fall while maintaining the target price: This is described in
your book and is done for some crops. In the graph above it would mean that consumers
could buy milk at 50¢ while farmers still get $4 per gallon. Both win! Of course the $3.50
difference must be paid for by taxpayers.
- Sell it abroad. We dump our excess crops on world markets and get whatever we can for
them. It is always less than what we paid to our farmers to have it produced – but at least we
get something back for it.
- Give it away as food aid to developing countries. Does the US give
thousands of bushels of food aid to developing countries every year because we
are concerned about the plight of the poor people in faraway lands? Yeah
right. In fact this program is driven by our need to do something with our
food surpluses – and this allows us to get rid of it under the cover of
helping others. But the politics are clear when you consider the
inefficiency of the program. First off, US food aid must be grown in the
US. And 75% of it must be shipped on vessels owned by US
companies… which can, thus, charge steeper prices than foreign shipping
companies. Costs are also increased because it must be packed in small
bags to allow for unloading by hand in less developed countries (LDCs). If we really wanted
to help we would buy locally as it would be much cheaper and would support poor farmers.
Excerpts from a 10/26/05 Wall St. Journal article Farmers, Charities Join Forces to Block
Famine-Relief Revamp say it best:
-
“While parts of Africa are of Uganda Grain Traders Ltd., have bought Ethiopian wheat in
routinely wracked by hunger, … calculates that USAID spent 2002 to use as food relief. Such
some countries often produce $447 per ton for U.S. corn a move also would have
surpluses of wheat and corn. In delivered to his country. The stabilized prices and supported
2003, for instance, the U.S. sent cost for Ugandan corn: $180 the local farm economy.
roughly 100,000 tons of per ton. Instead, in 2003, the U.S.
American-grown grain to With respect to Ethiopia: “A rushed in $500 million of U.S.
Uganda at a cost of $57 million bumper wheat harvest (in 2002) food to feed 13 million starving
to feed people in the country's depressed local prices so Ethiopians. The American food
north. At the same time, sharply that farmers were traveled on roads that ran right
Ugandan farmers elsewhere discouraged from planting. past local warehouses filled
were producing surplus crops When drought hit in 2003, with the 2002 Ethiopian
their government couldn't production was further slashed harvest.”
afford to buy and transport. and a famine was born. Mr.
John Magnay, chief executive Natsios said the U.S. should

There is another problem related to dumping (or giving away) our government-created farm surplus.
One of the things that LDCs are competitive at is food production. As the wealthy countries dump
surpluses onto their economies it destroys the agricultural sector – as it
is pretty hard to compete with free. For example, cotton is the primary
foreign exchange earner Mali, Benin, and Burkino Faso… together more
than 10 million people are directly dependent on cotton farming in these
countries. The US spends between $3 bn and $4 bn in subsidies to our
25,000 cotton farms. This works out to between $120,000 to $160,000 /
year / US farmer in subsidies – that is before they even get to sell their
cotton! US cotton growers get more in subsidies than the GDP of
Burkino Faso.
At the same time we put up barriers to imports of foreign food – because the goal of the policy is to
subsidize US farmers – not the world’s farmers. So it is hard for poor farmers to sell to US consumers.
This is the most hotly contested issue in world trade talks today. And it is not only the US that protects
its farmers. In fact, the EU, with its Common Agricultural Policy (CAP) spends almost twice what we
do in farm support. It is said that each cow in the EU gets $2 per day in subsidy – more than 1/2 of the
world lives on. Japan and South Korea also coddle their farmers. The annual value of farm subsidies in
the rich world (around $300 bn per year) far outstrips the annual value of foreign aid for the poor
world (around $50 bn per year).

The LDCs are saying, “Hey… you rich countries are hypocritical. You talk about free trade this and
free trade that… but when it comes to one of the few products we can actually compete in (food) you
a) subsidize your farmers, b) dump your excess crops into our markets and c) close off your markets to
our exports– the richest markets in the world.” You make the call.

Targeting: are we helping the hardworking family farm with these programs?

First I would note that while farmers do have a tough life… lots of people have a tough life. Janitors at
Foothill have a tough life. Waitresses in Peoria have a tough life. Are farmers deserving of special
treatment? Farm households actually have incomes 15% higher than the US average!

But it is a moot point… small family farms have been largely replaced by huge tracts of land owned
by multinational corporations like Cargill and Archer Daniels Midland (ADM). Less than 1% of the
US lives on farms today. Who gets the bulk of the subsidies? Yes, that is right. The large
multinationals do… 72% of federal farm payments go to 10% of producers. The 2005 WSJ article
cited earlier notes that, “Cargill has sold $1.09 billion of grain to the U.S. government for use in
foreign food-aid programs since 1995.” So that is somewhere around $100 million per year. Is it any
wonder that the farm subsidy program is commonly referred to as welfare for the rich?

Let’s return to the excess supply for a second. Can’t we just have producers produce Qd instead of Qs
in the graph above? That would avoid the creation of the surplus.

Fine idea but you have an allocation problem that mirrors the one we saw with a price ceiling. How do
you allocate the right to produce at this artificially high price? All farmers want to produce more at
this price… so you have to somehow physically restrain that excess production. How? The most
common way to do this is to have a government created production license. In order to produce you
must have a government license. These could be sold or, more likely, granted based on past production
history. So, for example, is it illegal for you to grow and sell peanuts. Don’t do it… it is the law. You
now have to worry about black market sales (illegal production and sales below the floor price). So
you have policing costs. All this government bureaucracy is part of the costs of the program – the
consumption of resources that could have been doing something else.

Another way to avoid the surplus is, famously, to pay the farmers not to produce. You say to Farmer
Jed, “We figure you were going to produce 100,000 bushels of corn this year… so how about if we
pay you for 100,000 bushels of corn but, and this is the key, you can not produce any of it.”

Jed will say, “Hmm… you drive a hard bargain… but I think I can work with you.”

Here is a mock letter to the Secretary of Agriculture. If it were not so true it would be pretty funny…
******************************************
Honorable Secretary of Agriculture

Dear Sir:
My friend, Ed, over at Wells Iowa, received a check for $1000
from the government for not raising hogs. So, I was wondering
if I could get into the "not raising hog" business next year.

What I want to know is, in your opinion, what is the best kind of
farm not to raise hogs on and what is the best breed of hogs not
to raise? I would prefer not to raise Raserbacks but if that is
not a good breed not to raise then I will just as gladly not raise
Yorkshires or Durocs.

As I see it, the hardest part of this program will be in keeping an accurate inventory of how many hogs
I have not raised. If I get $1000 for not raising 50 hogs will I get $2000 for not raising 100 hogs? I
plan to operate on a small scale at first, holding myself down to about 400 hogs not raised which will
mean about $80,000 the first year. Then I can afford an airplane.

Now, another thing. These hogs I will not raise will not eat 1,000,000 bushels of corn. I understand
that you also pay farmers to not raise corn and wheat. I am not a very good farmer so this seems
perfect for me. My question is will I qualify for payments for not raising wheat and corn not to feed the
4,000 hogs I am not going to raise?

In view of these circumstances you understand that I will be totally unemployed and plan to file for
unemployment and food stamps. You can be sure you will have my vote in the coming election.

Patriotically Yours,
P.S. Would you please notify me when you plan to distribute more free cheese?

If this policy does not make much sense… why do we have it?

The answer is simple. Politics. Here in the US we all pay over twice the world price for sugar. So
instead of paying 30¢ per pound (for example) we pay 60¢ per pound. Do you really
care? Do you even know about this? No and probably not. You are not going to waste
your time and energy fighting for a removal of sugar barriers… and you certainly are
not going to change your vote for a political candidate based on this trivial issue. But
do you know who else pays 30¢ “too much” for sugar? Me. And my mom. And your
mom… and … well I could go on for quite awhile. There are 300 million
Americans all paying a little too much for sugar. When you add it up it is a big
chunk of money. And where is it going? It is all going to benefit the tiny share of
our population that is involved in sugar production. To them it is a HUGE deal.
Billions of dollars. They will vote based on this issue. They will support sympathetic
Congressmen. And they will hire lobbyists to get Congress and the general public to
believe this is a good policy. They will pull out every trick in the book to maintain
the protections: the barriers protects job; it is a matter of national security; foreign
countries produce sugar unfairly. Always be sure to look at exactly who is making
these arguments. Typically it is someone that conveniently enough benefits from the
argument.

This is a fairly common dynamic: the costs of the policy are spread out among millions of
consumers while the benefits are concentrated on a small group of people. A politician can either
vote for maintaining the protections – and win the support of the farm lobby while not paying much of
a political cost from the 99% of the population that neither know or care … OR they can vote to
withdraw protections and suffer the wrath of the farm lobby all the while not picking up political
points from the rest of us (who still neither know nor care).

In 2006 there was legislation in the US Senate to cut the maximum annual subsidy one farmer could
get from $360,000 down to $250,000. It was defeated (46-53). We couldn’t even limit the subsidy to a
quarter of a million dollars per year! My hope is that eventually pressure from the World Trade
Organization gets us to change – our politicians can blame the WTO (as seems to be so trendy these
days) for forcing us to change our ways.

If you want to learn more go to the environmental working group Farm Subsidy Database (ewg.org)
and have a snoop around. I found a guy on my street who is getting corn and soybean subsidies for
land in Iowa. He has never been a farmer but he was shrewd enough to buy into land that gets an
annual subsidy from the government. He is not a bad guy… he is just taking advantage of a bad policy.

Quiz 1 is next…
Here is one worksheet question for you. The answer is on the next page… please solve it before
looking!!

1. Suppose the annual S&D curves for yo-yos in the U.S. are given by the equations:
Qd = 130 – 20 P
Qs = 10 + 40 P

where Qd = quantity demanded (millions); Qs = quantity supplied (millions); P = price (in dollars).
Calculate the equilibrium price and quantity.
 Answer to the problem above:

1. Suppose the annual demand and supply curves for yo-yos are given by the equations:
Qd = 130 – 20 P
Qs = 10 + 40 P
Calculate the equilibrium price and quantity.

In equilibrium Qd = Qs= Q*. Thus, set Qd = Qs = Q* and solve for equilibrium P (P*).
130 – 20 P = 10 + 40 P
120 = 60 P
2 = P*
Know we can plug this back into either of the two original equations and solve for Q*.
Qd = Q* = 130 – 20 (2) = 90

The equilibrium price is $2 and the equilibrium quantity exchanged is 90.

The following two graphs are used in homework 2