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Effects of Taxes and Subsidies on the Demand and Supply of Milk

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Suppose the demand and supply for milk are described by the following equations: QD = 600 - 100P; QS = -150 + 150P, where P is price in dollars, Q D is quantity demanded in millions of gallons per year, and Q S is quantity supplied in millions of gallons per year.
1. Create demand and supply tables corresponding to these equations and determine equilibrium price and quantity.
Now suppose the U.S. government imposes a $1 per gallon of milk tax on dairy farmers.
2. Using the demand and supply equations from question 1: What is the effect of the tax on the supply equation? The demand equation? What is the new equilibrium price and quantity?
3. How much do dairy farmers receive per gallon of milk after the tax? How much do demanders pay?
Now suppose the tax is placed on the buyers of milk. Does it matter who pays the tax?
Now repeat questions 2 and 3 assuming the government pays a subsidy of $1 per gallon of milk to farmers.
For Discussion: what does this problem suggest to you about the impact of government involvement in the supply and demand of specific products? How might similar involvement impact your company?
4. Answer the current debate over raising the minimum wage.
1. Is a minimum wage an equilibrium wage, a price ceiling, or a price floor?
2. What are the Pros and Cons about raising the minimum wage? (Use economic theory to defend your pros and cons, don't just make them up.)

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Solution Summary

There are two problems. The first problem is quatitative. It studies the effect of taxes and subsidies on equilbrium prices and quantities and step by step calculations are provided in this solution. The second problem is discussion type. Effect of raising minimum wages is explained with the help of diagrams in 572 words.

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Solutions

1. Create demand and supply tables corresponding to these equations and determine equilibrium price and quantity.
Qd=600-100P
Qs=-150+150P
For Equilibrium, Qd=Qs
600-100P=-150+150P
600+150=100P+150P
P=750/250=3
Qd=600-100*3=300
Qs=-150+150*3=-150+450=300
At Equilibrium position Price will be $3 per gallon, Quantity will be 300 million gallons per day

Price in dollars per gallon P=1 P=2 P=3 (Equilibrium) P=4
Qs (millions gallons per day) 0 150 300 450
Qd (millions gallons per day) 500 400 300 200

Now suppose the U.S. government imposes a $1 per gallon of milk tax on dairy farmers.
2. Using the demand and supply equations from question 1: What is the effect of the tax on the supply equation? The demand equation? What is the new equilibrium price and quantity?

Now let us see what happens if Farmers have to pay a tax of $1 per gallon of milk.
If P is the price of Milk buyers are paying, (P-1) will be the price sellers will be getting after tax.
Let us put it in Supply equation
Revised Qs=-150+150(P-1)
Qs=-150+150P-150
Qs=-300+150 P
Demand equation will remain the same
For equilibrium position Qd=Qs
600-100P=-300+150P
100P+150P=600+300
250P=900
P=900/250=3.6
Qd=600-100P=600-3.6*100=600-360=240
Qs=-300+150*3.6=240
New Equilibrium will be at price=$3.6 per gallon and Quantity of 240 million gallons per day.

3. How much do dairy farmers receive per gallon of milk after the tax? How much do ...

Solution provided by:
Lokesh Jain, MSc
Education
  • BEng (Hons) , Birla Institute of Technology and Science, India
  • MSc (Hons) , Birla Institute of Technology and Science, India
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