Question

Question 1
(a) (i) The perfectly competitive market for housing in Tembusu-land is at equilibrium. Suppose migration surges to Tembusu-land because of an economic boom. There are no changes in construction technology or manpower.
Use a well labelled supply-demand graph to explain the effects of these events on the Tembusu-land housing market equilibrium.
(ii) Explain how the effect of increased migration differs between the short-run and the long-run, focusing on potential differences between short-run and long-run housing supply elasticities. Assume increased migration is the same in both the short-run and long-run. Compare the predicted effects to those in Question 1(a)(i). Use a well labelled supply-demand graph to support your answer.
(b) (i) When the price of petrol is $2.00 / liter, Sunny petrol station sells 5,000 liters a week. When the price of petrol falls to $1.90 / liter, Sunny petrol station sells 5,500 liters a week.
Determine the price elasticity of demand for petrol using the mid-point method. Use three (3) decimal places in your computation (e.g. 0.000).
(ii) Explain the effect of increasing car taxes on petrol revenues, using the elasticity between car demand and petrol demand in your answer. Describe the technical economic term for the relevant elasticity, and whether the elasticity is positive or negative.

Answer 1

A. (i). The housing market in tembusu land is perfectly competitive, therefore the equilibrium quantity and price is determined by the intersection of demand and supply curves.

When the migration surges to tembusu-land due to an economic boom, the demand for housing increses from D₀​​​​​​ to D₁ as shown in figure below. Initial equilibrium price and quantity are given by p⁰ and q^{​​​​​​0} respectively.

The supply for housing is price inelastic as it needs manpower and time to increase the supply.

Thus with the increased demand, in order to maintain the equilibrium, either the price must rise to p¹ or the quantity must rise to q^1.

(ii). In the short run, the supply curve is price inelastic whereas in long term the supply curve is an upward sloping curve as the supply increases with the increase the price of housing.

When increased migration is same in both the long term and short term, then in short term to restore the equilibrium price must increase from p⁰ to p¹ ​​​​​​.

While in long term, when demand shifts from D₀ to D_1,​​​​​ and supply curve being upward sloping then both the quantity and price rises (to q¹ and p^{​​​​​​1} respectively) to restore the equilibrium.

B. (i). Mid pint elasticity = (Q₂ - Q₁​​​​​) /[(Q₂​​​​​​+Q₁​​​​​​1)/2] ÷ (P₂​​​​​​ - P₁​​​​​​1)/[(P₂​​​​​​+P₁​​​​​) /2]

Q₂​​​​​​= 5500 Q₁​​​​​​= 5000 P₂​​​​​​= 1.90 P₁=2

Price elasticity of demand for petrol = (5500-5000)/[(5500+5000)/2] ÷ (1.90-2)/[(1.90+2)/2] = - 1.857

(ii). When car taxes are increased then price of car (P_c​​​​​​) increases.

Due to this the demand for cars (D_c​​​​​​) decreases. Since petrol amd cars are complementary goods, therefore, with reduced demand for cars, demand for petrol (D_p​​​​​​) also decreases.

Elasticity between car price and petrol demand is given by

CROSS PRICE ELASTICITY =% change in D_p/ %change in P_c

Since, car price and petrol demand move in opposite direction(being complementary goods) , thus the cross price elasticity will be negative.