Question

Every house in a small town has a well that provides water at no cost.

However, if the town wants more than 10,000 gallons a day, it has to buy the

extra water from firms located outside of the town. The town currently

consumes 9,000 gallons per day.

a. Draw the linear demand curve (just be sure to obey the law of demand).

b. The firms’ supply curve is linear and starts at the origin. Draw the market

supply curve, which includes the supply from the town’s wells (you need to

add the two supply curves.).

c. Show the equilibrium. What is the equilibrium price and equilibrium

quantity?

Answer 1

a) The linear demand curve which follows the law of demand is negatively sloped. Also it is given that the town currently consumes 9000 gallons a day, hence the demand curve will intersect the quantity line at 9000.

Hence let the general demand curve be P = 1000 - Q

where P is the price and Q is the quantity.

Graphing this :

b) The supply curve will be drawn from the following fact: The town receives 10,000 gallons at no price and after that it has to buy water at an extra price. Since price is not given, a general upwards sloping supply curve is drawn.  

Hence the graph will coincide with the quantity line till Q = 10000 (because in this situation price is 0) and then go upwards and P = Q line. This is illustrated as follows:

The Green line shows the supply curve for water.

c) The equilibrium occurs where the demand curve intersects the supply curve.

Equilibrium is denoted by E*. Hence the equilibrium price, P = 0 and equilibrium quantity is 9000 gallons. This shows that no extra water was bought from the other town.