Question

Draw a supply and demand diagram with a perfectly elastic Supply.

a- Determine the equilibrium price and quantity on your graph. Label the relevant area of the graph with letters and determine consumer surplus, producer surplus and total surplus of the market at the equilibrium.

b- Show that any deviation from the equilibrium results in a decrease in total surplus.

c- Show the change in consumers, producers, and total surplus of the market as a result of an upward shift in the demand curve.

Answer 1

(a) When supply curve is perfectly elastic then , it will be a horizontal line . Demand curve is downward sloping .

Equilibrium price and quantity is where it supply curve and demand intersects .Equilibrium price is P* and equilibrium equantity is Q*.

Consumer surplus is the area above the price P* and below the demand curve. It is shown in the figure below by the shaded region.

Producer surplus is the area above the supply curve and below the Price line P*. But here the supply curve is horizontal , therefore producer surplus is equal to zero.

Total surplus= PS + CS = CS.

It is represented in the following graph :

(b) When there is any deviation from equilibrium , it implies that there will be change in quantity because price will remian the same as it is perfectly elastic supply. Then , as a result consumer surplus decreases , whether there is increase or decrease in quantity . Therefore, there is decrease in total surplus.

(c) When there is shift in demand curve from D1 to D2. Then , consumer surplus increases as it is shown in the below figure. And producer surplus will agian be equal to zero. Total surplus is equal to consumer surplus .It implies total surplus will also increase.