Question

Consider a closed economy. Let the demand curve be P = 80 - Q and the supply curve be P = 20 + 2Q

a) Calculate the equilibrium price and equilibrium quantity.

b) Suppose the government sets a price ceiling of $55, what is the amount of excess demand or excess supply? (Write down excess demand or excess supply).

c) Suppose the government sets a production quota of 16 units, calculate the equilibrium price and equilibrium quantity.

Answer 1

a. The equilibrium price and equilibrium quantity is determined where the demand curve intersects the supply curve.

Or, 80 - Q = 20 + 2Q

Or 3Q=60

Or, Q = 20 units.

At Q = 20, P can be found out by putting the value of Q in any of the supply or demand equations.

We get, P = $60.

Hence, these are the equilibrium price and equilibrium quantity.

b. The price ceiling sets the price which is lower than the equilibrium price level. As is shown in the diagram, this will lead to excess demand.

In order to calculate the value of excess demand, we need to first calculate the value of demand and supply at the price of $55.

At P = 55, Demand = 80 - 55 = 25 units.

Supply, = 55/2 - 10 = 17.5 units.

Thus, the excess demand is of 25 - 17.5 = 7.5 units.

C. Production quota implies that the supply gets fixed at 16 units and this makes the supply curve perfectly inelastic.

Now, new equilibrium will be attained where the demand curve intersects the new supply curve.

Or, 80 - P = 16

P = $64

The quilibrium quantity is fixed and it will be 16 units only.