Question

2. Suppose the equilibrium price of gasoline is $3 per gallon.

a. Using the demand and supply graph, draw this equilibrium in the space below. Make this graph large, it will be used for future questions.

b. Now suppose the government imposes a binding price floor on this market. Identify a value for this price floor that would be binding and show it on the graph. Graphically show whether excess demand or excess supply would result.

c. With the price floors, will consumers buy more or less gas? Identify the quantity that consumers will buy on the graph above.

d. On your graph above, identify the area that would represent the remaining consumer and producer surplus with the price floor in effect.

e. What forms of non-price competition might we expect to see in this market? Give some examples and explain WHY these would happen.

Thank you very much.

Answer 1

Given that equilibrium price of gasoline is $3 per gallon

a) Figure 1 attached below show demand and supply curve in gasoline market where E show the initial equilibrium with P=$3 as equilibrium price and Q as the equilibrium quantity of gasoline in gallons.

Figure 1

b)  Let government imposes a binding a price floor equal to P1 (green line in figure 2 below). In this market it will occur at a point greater than equilibrium price P=$3. Excess supply is shown by the arrows in figure 2 below. Excess supply exists because supply at P1 is QS which is greater than quantity demanded for gasoline (QD) at P1.

Figure 2

c) With price floor consumer's will now buy less quantity of gasoline as for them price has increased. Consumers at P1 will only buy QD quantity of gasoline as indicated in Figure 2 above.

d) In figure 3 below consumer surplus is represented by red shaded area with price floor effect which indicates the difference between price what they pay (P1) and what they are willing to pay for gasoline and producer surplus is represented by blue shaded area with price floor effect which indicates additional surplus enjoyed by sellers for a price higher than they would be willing to sell gasoline for in the market.

Figure 3