Question 2 (30 marks) Consider a market with demand characterized by Q = 70 – P....

Question 2

Consider a market with demand characterized by Q = 70 – P. Suppose the market is characterized by perfect competition, and aggregate supply is represented by Q = -20 + 4P.

A) Are all firms identical in this market? Why or why not?

B) Calculate equilibrium price and quantity.

C) Determine producer and consumer surplus associated with this market. Is total surplus maximized? How do you know?

Expert Solution

Ans A). All firms are identical in this market.A firm’s decision about how much to produce or what price to charge depends on how competitive the market structure is. If the Cincinnati Bengals raise their ticket prices by 5%, there will be a small reduction in the quantity of tickets demanded. If the corner gasstation raises its gasoline prices by 5%, there will be a huge reduction in the gas demande .All firms in perfect competition are price taker they connot change anything otherwise they have to face huge loss.Because of this reason all firms are identical in this market.

ANS B).

Ans C). Let assume the P* is the equilibrium price and Q* is the equilibrium quantity. Demand line shows the willingness to pay that is P* for Q* quantity. consumer surplus is achieved in an amount equal to the distance between the demand curve and P*. As a result, the shaded area in the chart ( given below) indicates the total consumer surplus achieved in the market.To calculate the total CS , first we have to calculate the total shaded area of triangle with area formula (1/2.b.h). Diagram is given in picture.

Producers surplus is value which he derive from transaction, means if he wanted to sell his product at $5 but finally he sold his product at $10 than PS will be $5 per unit.Like consumer surplus, producer surplus can also be shown via a chart of supply and demand. This time, however, the surplus from each transaction is represented by the distance between the supply curve (which denotes the lowest price suppliers would be willing to accept) and the market price. The total producer surplus achieved in the market would be represented by the horizental line area in the chart.

Rahul Sunny answered 2 years ago

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