A subsidy to wheat farmers reduces the price of a bushel of wheat from $2.50 to $2 per bushel. The equilibrium quantity of wheat sold prior to the subsidy was equal to 200,000 bushels. Predict the new equilibrium quantity of wheat after the imposition of the subsidy given that the demand for wheat is known to be unit elastic.
A)100,000 bushels
B)200,000 bushels
C)250,000 bushels
D)400,000 bushels

Question

A subsidy to wheat farmers reduces the price of a bushel of wheat from $2.50 to $2 per bushel. The equilibrium quantity of wheat sold prior to the subsidy was equal to 200,000 bushels. Predict the new equilibrium quantity of wheat after the imposition of the subsidy given that the demand for wheat is known to be unit elastic.
A)​100,000 bushels
B)​200,000 bushels
C)​250,000 bushels
D)​400,000 bushels

Quizplus · Accepted Answer

The demand for wheat being unit elastic means that the percentage change in the quantity demanded will be equal to the percentage change in price. With the price reduction of $0.50 due to the subsidy, it represents a percentage change of 20% ($0.50/$2.50). Therefore, the quantity demanded will increase by 20% as well, leading to a new equilibrium quantity of 240,000 bushels [(1+0.20) * 200,000]. However, this is not the final answer as the subsidy will also affect the supply side. Due to the subsidy, producers will have an incentive to produce more wheat, which will shift the supply curve to the right, further increasing the quantity supplied and lowering the price. The final equilibrium quantity will be at the intersection of the new demand curve (which is still unit elastic) and the new supply curve. Based on the information given in the question, we cannot determine the exact shift in the supply curve, but we know that it will lead to an increase in quantity supplied and a decrease in price. Therefore, the only answer choice that is close to the initial calculation of 240,000 and also takes into account the supply side effect is C) 250,000 bushels.

A Subsidy to Wheat Farmers Reduces the Price of a Bushel