Theory question 102
Price DeterminationThe diagram below shows the effects of the introduction of a subsidy on the production of maize. Study the diagram and answer the questions that follow:
(a)(i) Identify the curves labelled X, Y and Z. (ii) State the direction of change in price and quantity with the introduction of subsidy.
(b) Calculate the total revenue of the producers: (i) before the introduction of subsidy; (ii) after the introduction of subsidy.
(c) Calculate the percentage increase or decrease in the total revenue of the producers with the introduction of subsidy.
(d) If the quantity demanded of maize increases from 20 to 40 bags as a result of a fall in price from $15 to $10, calculate the price elasticity of demand.
(e) State the type of elasticity of demand in 2(d).
Show the model answer
(a)(i) X = demand curve; Y = original supply curve (before subsidy); Z = new supply curve (after subsidy).
(ii) Price falls from $15 to $10; quantity rises from 20 to 40 bags.
(b)(i) 15 × 20 = $300; (ii) 10 × 40 = $400
(c) (400 − 300)/300 × 100 = 33.3% increase
(d) % change in quantity = 20/20 × 100 = 100%; % change in price = −5/15 × 100 = −33.3%; Ed = 100 ÷ 33.3 = 3 (ignoring the sign)
(e) Elastic demand (coefficient greater than 1).
A subsidy shifts supply to the right.