Question

In 1995, the Food and Drug Administration (FDA) published new labeling standards for bottled water. (The full text of the final rule can be found at http://cfr.vlex.com/vid/165-110-bottled-water-19705533.) Prior to that time, bottlers could sell regular tap water under a bottled water label. In fact, the FDA estimated that approximately 25 percent of the supply of bottled water was nothing more than ordinary tap water. (a) Consider how these tougher standards eliminated 25 percent of the supply of bottled water. If market demand is unaffected, what qual itative impact would this labeling change have on equilibrium price and quantity for bottled water? Support your answer with a graphical model (b) Let the market demand and market supply equations are Q100P+ 1,150 and s supplied in a static efficient allocation and at what price? 400P 100. How much of bottled water would be Now, suppose the change in standards results in a new market supply of e400P - 350 with no change in market demand (c) Determine the new static efficient allocation for bottled water and new market price. Do your results agree with your intuitive answer to part (a)?

Answer 1

a) The elimination of 25% of the water supply due to change in labeling standards (factor exogenous to the model) will result in a leftward shift in the supply curve. this will result in a increase in the equilibrium price and a decrease in the equilibrium quantity of bottled water.

The following image shows the impact of the labelling (decrease in supply) on the equilibrium price and quantity.

a) the elimination of 25% the water supply due to change in labeling standard (factor exogenous to the model) will result in a leftward shift in the supply curve this will result in a increase in the equilibrium price and a decrease in equilibrium quantity of bottle water the following image shows the impact of the labeling (decrease in supply) on the equilibrium price and quality the supply curves shift from S_1 to S_2 and the equlibrium from e_1 to e_2 equilibrium price rises from P_1 to P_2 and equilibrium quality falls from Q_1 to Q_2 b) quantity and price at static efficient allocation Q^D = -100P + 1,150 Q^S = 400P - 100 equilibrium: Q^D = Q^S rightdoublearrrow -100P + 1,150 = 400P -100 rightdoublearrrow 1,250 = 500P rightdoublearrrow P = 2.5 rightdoublearrrow Q^D = Q^S = 400P - 100 = 400(2.5) - 100 = 1000 - 100 = 900 P* = 2.5, Q* = 900 from the above solution we get at static efficient allocations as P_1 = 2.5 Q_1 = 900

The supply curve shifts from S_{1 TO} S_2. and the equilibrium from e₁ to e₂ . equilibrium price rises from P₁ to P₂ and equilibrium quantity falls from Q₁ to Q₂ .

b) Quantity and Price at static efficient allocation

from the above solution, we get values at static efficient allocation as

P₁=2.5 and Q₁=900

c) change in supply curve with demand constant

the new equilibrium price and quantity under the new supply curve are P₂ andQ_2. solving for these values with new equation for supply:

the new equilibrium values we get for the new supply curve are

P₂=3 and Q₂=850

this corroborates the answer for (a) which says new supply will result in an increase of equilibrium price and a decrease of equilibrium quantity