Question

Suppose annual inverse demand and inverse supply for groundwater for irrigation purposes are given by the following equations, where ? is millions of acre feet of water:

Demand: ? = 18 − 2Q/3

Supply: ?=1?/3

1. Draw the demand and supply curves. Compute the equilibrium quantity and price of water and indicate the equilibrium on the graph. Be sure to indicate the value of the vertical intercepts of the two lines. Label all the items in your diagram, especially demand, supply, ?∗, and ?∗.

2. Calculate consumer and producer surplus at the equilibrium outcome from part 1. Show your work. Indicate CS and PS on your diagram. (Recall that consumer surplus, for example, is the area under the demand curve and above the equilibrium price line.)

3. Suppose the government decrees that there shall henceforth be an absolute upper limit on groundwater use. The limit is set at ? = 12 million-acre feet. Calculate the loss in consumer and producer surplus that will result from the new restriction.

Answer 1