Delhi School of Economics

EC 001. Microeconomic Theory

Instructor: Parikshit Ghosh
Problem Set 1

1. The market demand and supply functions for widgets are as follows:

qd = 12 p
qs = 2p

(a) Calculate the equilibrium price and quantity.

(b) Suppose the government imposes a per unit tax of Re 1 on sellers. How is the economic burden
of the tax distributed across buyers and sellers?
(c) Calculate the deadweight loss of the tax.
(d) Consider a general tax rate t per unit, to be paid by sellers. Find the value of t that maximizes
tax revenue for the government.
(e) If the government chose t to maximize the sum of consumers’surplus, producers’surplus and tax
revenue, what would be the optimum choice?
(f) Taxes create deadweight loss in the markets on which they are imposed. What is the implication
of this observation for public …nance? Should we have minimal or even no government?

2. The demand and supply functions in a market are given by Qd (pb ) and Qs (ps ), where pb and ps are
the prices (net of taxes) paid by buyers and sellers respectively. The government wants to impose an
excise tax of t per unit of sale on sellers to maximize tax revenues. Derive a formula for the optimum
tax rate relating it to the price elasticities of demand and supply.
3. The demand and supply functions in a market are given by

qd = a bp
qs = cp

where a; b; c are positive constants.

(a) Calculate the equilibrium market price and quantity in the absence of any government interven-
tion.
(b) Suppose the government imposes a price ‡oor p, which is higher than the equilibrium price.
Calculate the deadweight loss assuming sellers only produce an amount equal to the quantity
demanded at the controlled price.
(c) A producers’lobby can in‡uence the government to set a price ‡oor that maximizes producers’
surplus rather than social surplus. What price ‡oor will the lobby recommend?
(d) Suppose instead of directly controlling the price, the government initiates a price support pro-
gramme. The objective is to purchase a certain quantity x from the market so that the resultant
equilibrium price is p. Calculate x as a function of p. Also calculate the deadweight loss created
by the programme, assuming the quantity procured by the government is not consumed by anyone
(it is either costlessly stored or destroyed).

4. Consider the linear demand and supply functions above. Suppose the government imposes a price
ceiling p, which is below the equilibrium price. However, the amount produced by …rms at the o¢ cial
controlled price is captured by unscrupulous middlement who sell it to consumers on an illegal but
competitive black market. Calculate the black market price, the reduction in consumers’ surplus,
pro…ts made by the black marketeers and the social deadweight loss.
5. For the linear demand and supply functions above, introduce a sales tax t, which is a fraction of the
market price p, i.e., the tax obligation per unit bought and sold is pt.

1
 (a) Calculate the tax burden on both sides of the market, i.e., how much the e¤ective price paid by
buyers or received by sellers changes as a function of t.
(b) What value of t maximizes social surplus?
(c) What value of t maximizes tax revenue?

6. The captain of a cricket team must choose the proportion x of his team that should be batsmen, and
the proportion y that should be bowlers. We ignore wicket keepers and allrounders, so that x + y = 1,
and assume that x can be any real number in the [0; 1] interval. The captain’s objective is to maximize
the run di¤erence between his side and the opposing team. The runs scrored by his own team is given
by some function b(x; ), while the runs scored by the opponents is another function f (y), where is
some parameter which represents the opponent’s bowling strength (for any given x, the team scores
fewer runs when is higher). Both functions are twice continuously di¤erentiable in their arguments.
Using the optimization techniques you have learned, try to answer the following question: if the team
is playing a stronger bowling side this week compared to last week ( is higher), should the captain
take more batsmen than he did last week or fewer? What assumptions do you need to make on the
properties of the run scoring functions to answer this question unambiguously?