Suppose milk and cereal are compliments and the demand for milk is ,where stands for millions of gallons of milk demanded, stands for the price of milk and stands for the price of cereal.The supply of milk is ,where stands for millions of gallons of milk supplied.The demand and supply of cereal are and ,respectively,where stands for millions of boxes of cereal demanded and stands for millions of boxes of cereal supplied.Suppose the government imposes a $2.00 per gallon tax on milk.In the new general equilibrium
A) The price of both milk and cereal increase
B) The price of milk increases and the price of cereal decreases
C) The price of milk decreases and the price of cereal increases
D) The price of both milk and cereal decrease

Question

Suppose milk and cereal are compliments and the demand for milk is  ,where  stands for millions of gallons of milk demanded,  stands for the price of milk and  stands for the price of cereal.The supply of milk is  ,where  stands for millions of gallons of milk supplied.The demand and supply of cereal are  and  ,respectively,where  stands for millions of boxes of cereal demanded and  stands for millions of boxes of cereal supplied.Suppose the government imposes a $2.00 per gallon tax on milk.In the new general equilibrium
A) The price of both milk and cereal increase 
B) The price of milk increases and the price of cereal decreases 
C) The price of milk decreases and the price of cereal increases 
D) The price of both milk and cereal decrease

Quizplus · Accepted Answer

When a $2.00 per gallon tax is imposed on milk, the supply curve of milk shifts up by $2.00. This means that at any given quantity of milk, the price of milk increases by $2.00. As a result, the demand for milk decreases, causing the equilibrium quantity of milk to decrease. The decrease in milk demand also reduces the demand for cereal since they are complements, causing the equilibrium quantity of cereal to decrease. Due to the tax, producers receive a lower price, so they supply less milk, which results in a decrease in the equilibrium quantity of milk supplied. However, the decrease in supply is less than the decrease in demand because the tax makes producing milk less profitable. As a result, the price of milk increases and the price of cereal decreases.

Suppose Milk and Cereal Are Compliments and the Demand for Milk