Question 5 [20 marks]

The table below shows the demand and supply schedules for milk in Cowland. A subsidy on

milk of $1 per gallon is proposed and the government asks you to examine the effects of the

subsidy.

Price

(dollars per

gallon)

Quantity demanded

(millions of gallons

per year)

Quantity supplied

(millions of gallons

per year)

1 320 0

2 240 0

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3 160 80

4 80 160

5 0 240

a) Draw the demand and supply curves. If there is no subsidy, what is the price of milk and how

many gallons are sold? (5 marks)

b) With the subsidy, what is the price that consumers pay? What is the price that sellers receive?

How many gallons of milk are sold? (5 marks)

c) Assuming no external costs and benefits, what is the efficient level of milk production?

(2 marks)

d) With the subsidy, what is the marginal social benefit from milk? What is the marginal social

cost of milk? If the subsidy is introduced, will the level of production be efficient? Why or why

not? (8 marks)