Question

1- Create a hypothetical market (make a table showing values for Quantity Supplied, Quantity Demanded and Price). Any values you like and make sense! Make at least 10 data points.

2- Write The supply & demand equations showing the slope and intercept. Comment on the two equations and on the values of the slope and intercept. What do they mean?

3- In the market that you have created calculate consumer surplus and producer surplus and show both in one separate graph.

4- In the market that you have created assume any possible price floor and any possible price ceiling. Show in a separate graph the impact of the price floor and in another graph the impact of the price ceiling.

5- On each graph calculate and show the market shortage and market surplus resulted from Price ceiling and Price floor.

6- Add a column to the initial table showing the elasticity of demand with respect to price at each price level.

7- What is happening to the elasticity (increasing, decreasing, constant?) as price gets lower? Why?

8- Question: According to the elasticity of demand, what would be more profitable to the suppliers; to raise the price or to lower it. Why?

9- Question: If you were to choose a market to start you own business in; which market you prefer; a market with price elastic demand or price inelastic demand? Why?

Answer 1

1. In H-market, demand is Q = 100 - P; Supply is Q = 2P
The table:

  
2. Demand function: Q = 100 - P. Y-intercept is 100 which means that the maximum willingness to pay for consumers is 100. Slope is -1 which means that for every change in price demand will change by 1 unit. Elasticity is unitary.
Supply function:Q = 2P. Y intercept is 0. It means that the minimum reservation price of sellers is 0. They have no fixed cost. Slope is +2. It means that for every change in dollar price, supply increases by 2 units.Supply is elastic.
3. The graph:

:

Equilibrium price = $50; quantity = 50
4. Consumer surplus and producer surplus:

Consumer surplus = ½*(100 - 50)*50 = 1250
Producer surplus = ½*(50-0)*50 = 1250
The area of conusmer surplus and producer surplus have been shaded and labelled.

5. Price floor:

Price floor, $70, is above the equilibrum price, so it is binding price floor. It creates surplus because supply is more than demand at $70.
Surplus = 40 (70 - 30 = 40)

6. Price ceiling:

price ceililing at $30 is below the equilibrium price, so it is binding. At $30, demand = 70, supply = 30. So there is shortage of 40 units.

7. The table with elasticity of demand (Ed) :

  

Point elasticity: Formula: Ed = (∆Q / ∆P) * P/Q. Here, ∆Q/∆P = -1 (as given in the demand equation, Q = 100 -1P). So, Ed is just P/Q at each level. Ed is expressed in absolute values in the table.

The elasticity is increasing as price deceases. This is because as we move lower on the demand curve, elasticity decreases and becomes perfectly inelastic at the horizontal axis. So in the table we have: when price = 0, Ed = 0 (perfectly inelastic at the horizontal axis).
This is because sensitivity of quantity to price becomes smaller as we move down the demand curve.

8. In the case of this example, producers are earning maximum revenue at equilibrium. So, they would not change the price. However, in general, if the demand is elastic, suppliers must decrease the price to increase revenue. This is because, when price decreases, quantity demanded would increase by more than proportionate amount, resulting in increase in revenue.

On the other hand, if demand is inelastic, sellers must increase price. The quantity demanded would decrease by less than proportionate amount, and revenue would increase.

9. I would prefer a market with inelastic demand. When an extraneous, unanticipated event (a seller's nightmare) would result in increase in price, demand would not change much. I would end up with more revenue.
Also, in another situation, with increase in input price, I can increase the price and end up with more revenue.