Question

Comparative Statics: Consider the market for taxi service in San Francisco. Explain how the following events ∗∗ will affect the equilibrium (? , ? ) in the taxi market . Consider each case separately. Use supply and demand curves to defend your answer graphically.

a) Bus fares increase after a strike by bus drivers.

b) Taxi drivers must pass a competency test, and one-third fail.

c. The price of a taxi permit increases and consumer income increases. Assume that taxi service is a normal good. Show each event on separate graphs. After you perform comparative statics for each graph, determine the overall net effect on P* and Q*. Note, if you get conflicting results, e.g. Price increases and decreases, then the net result is indeterminate.

d) Half the downtown parking lots are converted to office buildings.

Answer 1

a) Bus and taxi service is substitute to each other. Rise in bus fares will raise demand of taxi as consumers will taxi comparatively cheaper which will induce consumers to ride on taxi and raise its aggregate demand which will shifts its demand its demand curve to its right from AD to AD1 where price rise from P to P1 and output rises from Y to Y1.

b) As taxi drivers have to pass a competency test in which one third fail which will reduce the supply of taxi drivers and shifts the aggregate supply of taxis to its left from AS to AS1 where price rise from P to P1 and output falls from Y to Y1.

c) Price of taxi permit increases which eventually raise the cost of taxi drivers and induce them to reduce the supply of taxi because of falling profit. On the other hand, rise in income of consumers will raise demand of taxi (because of normal good). Net effect: Fall in supply from SRAS to SRAS1 and rise in demand from AD to AD1 which result in rise in price from P* to P2 while output remains same.

Assumption here is that effect of fall in supply = effect of rise in demand. If effect of fall in supply overweighs effect of rise in demand, output level will fall and vice versa.

d) As half of downtown parking lots are converted to office buildings, there would not be enough space to park taxi which will reduce the aggregate supply of taxi. It will raise price level from P to P1 and reduce output from Y to Y1.