Question One

Suppose that a government has decided to subsidise manufacturers of bicycles (maybe to help encourage more cycling because of cheaper high-quality bikes). The inverse demand for bicycles is initially given by P = 500 - 0.1Q^D

The inverse supply is P = 200 + 0.1Q^S

1. Calculate the equilibrium price and equilibrium quantity in this market.

1. Calculate the producer surplus and consumer surplus.

1. Suppose the government now offers a $100 per unit subsidy to bicycle manufacturers. Alter the equation for the inverse supply curve to reflect this subsidy.

1. With the subsidy in place, how many bicycles will be sold? What will be the price of a bicycle for a buyer? What price will sellers get?

1. What will the subsidy program cost the government? What will be the net effect of the subsidy on total surplus in society?