Question

Suppose the supply of coal is perfectly inelastic, and the price elasticity of demand for coal is -0.4. If the government imposes a binding price ceiling for coal at a price that is 20 percent below the market equilibrium price, what is the impact of this policy on the market quantity?

A) Excess demand equals 80 percent of the market equilibrium quantity B) Excess demand equals 8 percent of the market equilibrium quantity C) The policy does not affect the market quantity D) Excess demand equals 16 percent of the market equilibrium quantity

Answer 1

Consider the given problem here the supply of coal is “perfectly inelastic”, => totally vertical, now the demand curve is relatively inelastic having elasticity “-0.4”. Now, here the supply curve is vertical, => if “P” is ceiled below the equilibrium “P”, then the “excess demand” will create through the “demand side”.

Consider the following fig.

So, if the “P” is ceiled “20%” below the equilibrium “P”, => “the quantity demanded” will increase by “0.4*20=8%”.

=> So, the excess demand equals to “8%”, => the correct option is “b”.