Source: ECO 2013 Midterm 1 Practice Exam (Form A), University of Florida
Tags: price ceiling, price floor, minimum wage, excise tax, tariff, deadweight loss, imports, exports, world price, gains from trade, consumer surplus, producer surplus, tax revenue, price gouging
Difficulty: Introductory to Intermediate Prerequisites: Supply and demand (equilibrium, surplus, shortage, consumer and producer surplus).
Once you understand how a free market reaches equilibrium, this unit asks: what happens when the government steps in? Price controls force the price above or below equilibrium, taxes drive a wedge between what buyers pay and sellers receive, and trade opens the domestic market to the world price. Every intervention redistributes surplus among buyers, sellers, and the government, and most create deadweight loss. The pattern is the same each time: draw the diagram, identify the new quantity traded, and trace who gains, who loses, and how much.
Price ceilings (below equilibrium) create shortages; price floors (above equilibrium) create surpluses. Excise taxes shift the supply curve up by the tax amount, reduce the quantity traded, and generate government revenue. In international trade, a country exports when the world price is above its domestic equilibrium and imports when below. Tariffs raise the domestic price, help domestic producers, hurt consumers, and create deadweight loss.
Price ceiling
A legal maximum price set below the equilibrium price. It prevents the price from rising to equilibrium.
Think of it as a cap: the price cannot go above this level. The classic example is rent control. Price gouging laws are also a form of price ceiling.
Price floor
A legal minimum price set above the equilibrium price. It prevents the price from falling to equilibrium.
Think of it as a platform: the price cannot drop below this level. The most common example is the minimum wage.
Minimum wage
A price floor in the labour market. When set above the equilibrium wage, it reduces employment (fewer workers hired) and increases unemployment (more people want to work at the higher wage than firms want to employ).
Excise tax
A per-unit tax imposed on the sale of a good. It shifts the supply curve upward (leftward) by the amount of the tax, creating a wedge between the price buyers pay and the price sellers receive.
In simple terms, it is a fixed dollar amount added to the cost of each unit sold.
Tariff
A tax on imported goods. It raises the domestic price above the world price, reduces imports, increases domestic production, and generates government revenue.
Think of it as an excise tax that applies only to imports.
Deadweight loss (DWL)
The reduction in total surplus that results from a market distortion (price control, tax, or tariff). It represents trades that would have been mutually beneficial but no longer occur.
World price
The prevailing price of a good on international markets. When a country opens to trade, the domestic price adjusts to the world price.
Imports
Goods purchased from abroad. A country imports a good when the world price is below its domestic equilibrium price.
Exports
Goods sold abroad. A country exports a good when the world price is above its domestic equilibrium price.
Gains from trade
The increase in total surplus when a country opens to international trade. Trade creates winners and losers domestically, but the winners gain more than the losers lose, so total surplus rises.
A binding price ceiling is set below the equilibrium price.
At the ceiling price, quantity demanded exceeds quantity supplied, creating a shortage.
The quantity actually bought and sold equals the quantity supplied (the short side of the market).
Consumer surplus is ambiguous (some consumers pay less, but others are shut out). Producer surplus certainly falls.
Price gouging laws are a real-world example: during emergencies, they cap the price of essentials.
A binding price floor is set above the equilibrium price.
At the floor price, quantity supplied exceeds quantity demanded, creating a surplus.
The quantity actually bought and sold equals the quantity demanded (again, the short side).
Consumer surplus certainly falls. The effect on producer surplus is ambiguous.
The minimum wage is a price floor in the labour market. When set above the equilibrium wage:
Firms hire fewer workers (quantity of labour demanded falls).
More people want to work (quantity of labour supplied rises).
The result: employment falls and unemployment increases.
An excise tax is a per-unit tax. Graphically, it shifts the supply curve upward by exactly the amount of the tax (from S₀ to S₁).
The new equilibrium has a higher price for buyers and a lower effective price for sellers.
The quantity bought and sold falls.
The vertical distance between S₁ and S₀ equals the tax per unit.
Tax revenue = tax per unit x quantity sold after the tax.
From the exam graph (ice cream): the tax shifts supply up. Read the tax amount as the vertical gap between the two supply curves, then multiply by the new equilibrium quantity.
Example: if the excise tax is $2 per gallon and 200,000 gallons are sold, government revenue = $2 x 200,000 = $400,000.
The graph shows S₀ and S₁ (supply before and after the tax) and D (demand) in the ice cream market. The intersection of S₁ and D gives the new equilibrium. The vertical distance between S₀ and S₁ at any quantity is the tax. Read the new quantity traded from the x-axis at the S₁-D intersection.
A country exports when the world price is above the domestic equilibrium price.
Domestic producers sell at the higher world price, so producer surplus increases.
Domestic consumers pay more, so consumer surplus decreases.
Total surplus increases: the gains to producers outweigh the losses to consumers.
A country imports when the world price is below the domestic equilibrium price.
Domestic consumers buy at the lower world price, so consumer surplus increases.
Domestic producers receive less, so producer surplus decreases.
Total surplus increases: the gains to consumers outweigh the losses to producers.
Consumer surplus increases by more than producer surplus decreases.
At the world price, read the quantity supplied domestically and the quantity demanded domestically from the graph. The difference is the quantity imported or exported.
Example (rice market, world price $2): at $2, domestic quantity supplied is about 400 lbs and domestic quantity demanded is about 1,000 lbs. The country imports 600 lbs.
The gains from trade equal the increase in total surplus compared to the no-trade equilibrium. Graphically, it is the triangle between the domestic supply curve, the domestic demand curve, and the world price line, covering the range of quantities that are now traded internationally.
Example: if the world price is $2 and the trade quantity is 600 lbs, the gains from trade form a triangle. Base = 600, height = the price gap. Calculate area = 0.5 x base x height.
A tariff raises the domestic price above the world price (to world price + tariff). This:
Reduces imports (domestic producers supply more, domestic consumers buy less).
Increases producer surplus (Area A on the exam graph).
Decreases consumer surplus (Areas A + B + C + D on the exam graph).
Generates tariff revenue for the government (Area C).
Creates deadweight loss (Areas B and D).
The graph shows the US supply (S_US) and demand (D_US) curves, a horizontal world price line, and a horizontal world price + tariff line. The tariff equals the vertical distance between these two lines. Area A is the increase in producer surplus. Area C is tariff revenue. Areas B and D are deadweight loss.
Thinking a price floor creates a shortage. A floor above equilibrium creates a surplus (too much supplied, not enough demanded). A ceiling below equilibrium creates a shortage. Students often mix these up. A mnemonic: a ceiling holds the price down, a floor holds it up.
Assuming a minimum wage always reduces employment. It only reduces employment when it is set above the equilibrium wage. A minimum wage set at or below the equilibrium has no effect (it is non-binding).
Confusing who "certainly" loses under a price floor. Consumer surplus certainly falls. Producer surplus may rise or fall (some producers gain from the higher price, but quantity sold drops). The exam phrase is "certainly reduce consumer surplus."
Thinking a tariff helps the overall economy. A tariff helps domestic producers and generates government revenue, but it reduces consumer surplus by more. Total surplus falls (deadweight loss). The net effect is a loss, not a gain.
Mixing up tariff graph areas. Area A is the increase in producer surplus, not total producer surplus after the tariff. Area C is tariff revenue, not deadweight loss. Areas B and D are deadweight loss.
⚠️ Price control questions test whether you know which way the imbalance goes: ceiling = shortage, floor = surplus. Get this right and the rest follows.
⚠️ The minimum wage question always asks about the effects on employment and unemployment together. Employment falls, unemployment rises.
⚠️ Excise tax graph questions require reading the tax amount (vertical gap between supply curves), the new quantity (where the shifted supply meets demand), and calculating tax revenue (tax x quantity).
⚠️ Tariff graph questions require identifying the four areas (A, B, C, D) and what each represents. Practise labelling them on sight.
⚠️ International trade questions test the direction of trade (export if world price is above domestic equilibrium, import if below) and whether total surplus rises or falls.
⚠️ Price gouging laws = price ceiling. This is tested as a definition question.
A price ceiling set below equilibrium creates a ____ (shortage/surplus). Shortage.
True or false: A tariff increases total surplus. False. It creates deadweight loss, reducing total surplus.
A country imports when the world price is ____ (above/below) the domestic equilibrium price. Below.
Tax revenue from an excise tax = ____ x ____. Tax per unit x quantity sold after the tax.
Price gouging laws are an example of a ____. Price ceiling.
Q: A minimum wage set above the equilibrium wage ____ employment and ____ unemployment.
A: Reduces; increases.
Q: A price floor above equilibrium in the market for electric generators will ____ the quantity bought and sold and certainly reduce ____.
A: Reduce; consumer surplus. (Producer surplus may rise or fall, but consumer surplus certainly falls.)
Q: Price gouging laws are an example of a ____.
A: Price ceiling.
Q: The hot chocolate table shows equilibrium at $2.50 (Qd = Qs = 600). At $1.00, Qd = 750 and Qs = 525. What is the result?
A: A shortage of 225 cups (750 minus 525).
Q: The graph shows a tariff diagram with world price at $10 and world price + tariff at $12. What is the tariff?
A: $2 ($12 minus $10).
Q: In the tariff graph, Area C is the ____.
A: Tariff revenue (the rectangle between the world price and the world price + tariff, over the range of imports).
Q: In the tariff graph, Area A is the ____.
A: Increase in producer surplus due to the tariff.
Q: When the world price is above the domestic equilibrium price, the country will ____ the good and total surplus will ____.
A: Export; increase.
Q: When the world price is below the domestic equilibrium price, consumer surplus will ____ by ____ than producer surplus ____.
A: Increase; more; decreases. (Consumers gain more than producers lose, so total surplus rises.)
Q: The domestic rice market graph shows equilibrium at $3 and 800 lbs. The world price is $2. At $2, domestic supply is 400 lbs and domestic demand is 1,000 lbs. How many pounds are imported?
A: 600 pounds (1,000 minus 400).
Q: Using the same rice graph, the gains from trade at a world price of $2 equal ____.
A: $300. The gains from trade form a triangle: base = 600 lbs (the quantity imported), height = $1 (the gap between the domestic equilibrium price of $3 and the world price of $2). Area = 0.5 x 600 x $1 = $300.
Q: The ice cream graph shows two supply curves (S₀ and S₁). The vertical distance between them appears to be $2. After the tax, the new equilibrium quantity is 200,000 gallons. What is the government revenue?
A: $400,000 ($2 x 200,000).
Price controls and taxes build directly on supply and demand: every question in this section starts from a standard S&D diagram and adds a government intervention. International trade connects back to comparative advantage (from the PPF unit), since countries export the good in which they have a comparative advantage. Tariffs are essentially a special case of a tax, so the analytical tools (surplus areas, deadweight loss triangles) are the same.
Price ceiling, price floor, binding price control, non-binding price control, minimum wage, shortage, surplus, excise tax, per-unit tax, tax revenue, tax incidence, deadweight loss, tariff, import tariff, world price, domestic price, exports, imports, gains from trade, consumer surplus, producer surplus, total surplus, trade surplus areas, free trade, protectionism, price gouging, ECO 2013, principles of macroeconomics, UF econ midterm 1