ECN 502

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1) Problem 6: Suppose demand and supply are given by Qd = 60 – P and Qs = P – 20. a) What are the equilibrium quantity and price in this market? b) Determine the quantity demanded, the quantity supplied and the magnitude of the surplus if a price floor of $50 is imposed in this market. c) Determine the quantity demanded, the quantity supplied and the magnitude of the shortage if a price ceiling of $32 is imposed in this market. Solution: a. For the equilibrium i) Price: Qd = Qs 60-P=P-20 => P= $40. ii) Quantity: Equilibrium quantity can be found substituting the value of P found in (i). Q = 60-40 = $20 b. i) Quantity Demanded = Qd= 60-50= 10 ii) Quantity supplied = Qs= 50-20 = 30 iii) Magnitude of surplus =…show more content…
4) What are the (potential) explanations for the ‘puzzle’? 5) What are the policy implications of these explanations? Solution: 1) For the short- run elasticity is estimated to be between 0.1 and 0.2, which can be calculated by E = % change in demand / % change price. Similarly for long-run elasticity is estimated to be between 0.5 and 1. 2) Based on the recent experience elasticity was estimated as 3.5 % / 55% = .0636. 3) The ‘puzzle’ mentioned in the article is 10% increase in gasoline consumption when the gasoline prices surged by 53% from 1998 to 2004. As per Law of demand, the consumption of gasoline should have decreased with the increase in price of gasoline. 4) There are three factors cited in the article that leads to explanation of this puzzle: a) Many consumers viewed the recent price increase as temporary and didn’t shift to fuel-efficient alternatives. This view was probably based on the experience in 1980s and 1990s, when the price increase didn’t last. b) As per Pinelopi Goldberg, with the increase in gas prices the car companies lowered the big car prices. c) Also, as the income grew significantly in the late 1990s, income growth meant spending on gasoline had become a smaller share of the cost of driving. 5) The two ways to curb fuel consumption is to either increase the fuel tax or to put miles per gallon standards on vehicle manufacturers. But if the increase in fuel tax fails to curb the consumption, vehicle

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