AP_Krugman_Textbook

Tackle the Test:

Free-Response Question

2.

Module 9

Check Your Understanding

1. a.The price of a ride is $7 since the quantity demanded at
   this price is 6 million: $7 is the demand priceof 6 million
   rides. This is represented by point Ain the accompanying
   figure.

b.At 6 million rides, the supply price is $3 per ride, repre-

sented by point Bin the figure. The wedge between the

demand price of $7 per ride and the supply price of $3

per ride is the quota rent per ride, $4. This is represented

in the figure above by the vertical distance between

points Aand B.

c.The quota discourages 4 million mutually beneficial

transactions. The shaded triangle in the figure represents

the deadweight loss.

d.At 9 million rides, the demand price is $5.50 per ride,

indicated by point Cin the accompanying figure, and

the supply price is $4.50 per ride, indicated by point D.

The quota rent is the difference between the demand

price and the supply price: $1. The deadweight loss is

represented by the shaded triangle in the figure. As

you can see, the deadweight loss is smaller when the

quota is set at 9 million rides than when it is set at

6 million rides.

0 6 8 10 12 14

$7.00

5.00

3.00

Quantity of rides (millions per year)

Fare

(per ride)

D

A S

B

E

Deadweight

loss

QS QE QD

Quantity of housing

PE

Price of

housing

(rent)

S

D

E

Legal limit

(rent control)

Shortage

3. 
   

a.Some gas station owners will benefit from getting a

higher price. QFindicates the sales made by these own-

ers. But some will lose; there are those who make sales

at the market equilibrium price of PEbut do not make

sales at the regulated price of PF. These missed sales are

indicated on the graph by the fall in the quantity

demanded along the demand curve, from point Eto

point A.

b.Those who buy gas at the higher price of PFwill proba-

bly receive better service; this is an example of ineffi-

ciently high qualitycaused by a price floor as gas station

owners compete on quality rather than price. But oppo-

nents are correct to claim that consumers are generally

worse off—those who buy at PFwould have been happy

to buy at PE, and many who were willing to buy at a

price between PEand PFare now unwilling to buy. This

is indicated on the graph by the fall in the quantity

demanded along the demand curve, from point Eto

point A.

c.Proponents are wrong because consumers and some gas

station owners are hurt by the price floor, which cre-

ates “missed opportunities”—desirable transactions

between consumers and station owners that never take

place. The deadweight loss, the net gains forgone

because of missed opportunities, is indicated by the

shaded area in the accompanying figure. Moreover, the

inefficiency of wasted resources arises as consumers

spend time and money driving to other states. The price

floor also tempts people to engage in black market

activity. With the price floor, only QFunits are sold.

But at prices between PEand PF, there are drivers who

together want to buy more than QFand owners who

are willing to sell to them, a situation likely to lead to

illegal activity.

Tackle the Test:

Multiple-Choice Questions

1. e


2. b


3. e


4. b


5. c

Price of gas

Quantity of gas

E

D

S

A B

Price

floor

QF QE

PF

PE

S-6 SOLUTIONS TO AP REVIEW QUESTIONS