Question

Redistributing surplus

a. In the car market, use a supply and demand diagram to illustrate consumer and producer surplus.

b. You feel that car manufacturers are getting an unduly large share of the surplus from car sales.

1. Suggest a government policy that could increase consumer surplus.

2. Illustrate the effect of this policy in a supply and demand diagram. Indicate regions of consumer surplus, producer surplus, and deadweight loss if this policy were enacted.

3. Will your policy generate excess supply or excess demand? Are there any side effects of this?

Answer 1

Solution b:

i). One of the ways by which consumer surplus could increase would be by providing subsidy on fuel. Now since fuel and car are complementary goods, a reduction in market price for fuel will lead to increased demand and thus increased consumer surplus.

iii). This policy will generate excess demand. There could be side effects to it as increased demand for fuels would mean higher environmental consequences, for which the government will have to spend more in order to ensure a cleaner environment.