Question

Question 1

1. Draw the market for electric vehicles in initial equilibrium. Be sure to label the axes and the curves/lines. Clearly demonstrate the initial equilibrium price and quantity.
2. Suppose the cost of lithium-ion batteries, an input into the production of electric vehicles, has dropped more steeply than expected. Use the 4-step process to demonstrate the effect of this change in the market for electric vehicles. Explain why you have drawn the change you have.
3. Has there been a change in demand? Explain.
4. Analyze and explain the change in the equilibrium price and quantity. Explain.
5. Explain how any equilibrium price and quantity combination is efficient. Use 1 of the following in your explanation. Be sure to define your terms.
   1. producer and consumer surplus
   2. allocative and productive efficiency
   3. Pareto efficiency to address this.

Answer 1

The market for electric vehicles is drawn in figure 1. The supply and demand for electric vehicles intersect at a price of Pe where Qe amount of electric vehicles are sold and bought.

As the cost of lithium-ion batteries, an input into the production of electric vehicles, drops, it becomes more profitable for the firms to manufacture electrice vehicles. This shifts the supply curve from S1 to S2 and the price of electric vehicles falls from Pe to P1. The quantity of electric vehicles rises from Qe to Q1.

As the price falls, people start to demand more of electric vehicles as per the law of demand. There is movement along the demand cure as the price falls.

Consumer surplus = area above the price line and below the demand line (indicated by green area)

Producer surplus = area below the price line and above the supply line (indicated by red area)

total surplus = consumer surplus + producer surplus

Demand curve shows the value to buyers and supply curve shows the cost to sellers. When the quantity is below the equilibrium quantity (figure 2), then the value to the marginal buyer exceeds the cost to the marginal seller. In this case, if the quantity is increased, it would lead to an increase in the total surplus.  

At equilibrium, total surplus is maximum (figure 3).

At a quantity above equilibrium level (figure 4), then value to the marginal buyer is less than the cost to marginal seller, In such a case, reducing quantity would increase total surplus.

Therefore, only at equilibrium is the total surplus highest.