Question

DO ONLY PART D

2. A copy of a press release from Florida’s Department of Agriculture is shown at
the back of this problem set. The press release indicates that the prices of many
commodities like sheets of plywood, batteries, and bottled water increase during or after a
hurricane. The media sometimes refer to this increase in prices as “price gouging” and
there is often condemnation of these price increases. The press release from Florida calls
such price increases “immoral” and “illegal”. This problem examines some of the
economics of “price gouging”.
A. Suppose that the weekly demand for plywood sheets in Florida in normal times
is given by:
P = 120 - Qd
and the weekly supply of plywood is given by
P = 0.5 Qs,
where P is the price of a sheet of plywood in dollars, and Qd and Qs are the quantities of
plywood demanded and supplied (in thousands of sheets).
(1) Solve for the equilibrium price and weekly quantity of plywood bought and sold.
(Show your calculations.)
(2) Draw the demand and supply curves in a diagram and show the equilibrium price
and quantity. (I recommend using graph paper.)
B. Now suppose that there is a hurricane and the weekly demand for plywood
increases to:
P = 120 - 0.5 Qd.
Suppose that the supply curve stays the same as before.
(1) What will be the equilibrium price and quantity of plywood during a hurricane
week? (Show your calculations.)
(2) Show the new demand curve in your diagram in Part A and show the new
equilibrium price and quantity of plywood.
(3) Explain verbally why the equilibrium price of plywood changes from Part A to Part
B.
C. Suppose that the Florida government forbids prices of plywood to increase
during a hurricane week. That is, sellers of plywood are not allowed to raise prices above
the price that occurs during a normal week.
If raising price during a hurricane week is illegal, what would be the price of plywood
and the quantities bought and sold during a hurricane week in the example given above?
(Explain your calculations.) Show this outcome in your Figure.

D. Using the tools of consumers’ and producers’ surplus, evaluate the welfare
consequences of making price increases illegal during a natural disaster (as in Part C)
versus allowing prices to rise (as in Part B). That is, show the changes in consumers and
producers surplus and efficiency loss from the price control program. Be sure to label the
relevant areas in your diagram. You do not need to calculate the efficiency losses
quantitatively.

Answer 1

P = 120 - Qd or Qd = 120 - P

P = 0.5Qs or Qs = 2P

1) At equilibrium Qs = Qs

120 - P = 2P

120 = 3P

P = 40

Q = 80

2)

B)

P = 120 - 0.5Qd or Qd = 240 - 2P

Qs = 2P

Qd = Qs

240 - 2P = 2P

240 = 4P

P = 60

Q = 120

2)

3)

The increase in demand with the given supply created excess demand. The excess demand thus put upward pressure on prices causing both prices and quantity to rise.

C)

If the prices are not allowed to rise, the price would be $40.

At this price the quantity demanded would be Qd = 240 - 2P = 160

Quantity supplied Q = 2P = 80. Thus there would a shortage of 120 units.

D)

When the prices are allowed to rise the equilibrium is at point b. The consumer surplus is area abc. Producer Surplus is the area cob.

When the prices are not allowed to rise consumer surplus aedf. Producer Surplus is fod.

The Deadweight loss is edb

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