Question

Suppose there is a competitive market for road space. The demand for road space falls as the price
rises (due to the income and substitution effects). The supply for road space is fixed, which means
that the supply curve is vertical. Use appropriate diagrams to answer the following questions:
(a) What is the market price of road space in a competitive equilibrium?
(b) Suppose that road space is a public good, which is freely available to individuals. How much is the
excess demand for road space?
(c) Suppose we measure congestion by the amount of excess demand for road space. Can a rise in
fuel taxes and car taxes reduce congestion?
(d) Can building more roads reduce congestion? Would your conclusions change if, with more roads,
individuals were encouraged to drive more?

Answer 1

a)

The demand curve and the supply curve for a competitive equilibrium are given as :

Price($) Quantity(units)

The two curves intersect at the point P , which is the competitive price at which the given quantity is supplied an demanded , the competitive market price is given by the point where the supply and demand curve intersect.

b).Since road space is freely available its demand curve is given by x-axis at P = 0 and Q= infinite

and the supply curve is constant at Quantity = Q at all prices , so the excess demand is the difference between the quantity available and the excess demand which goes till infinite :

Price $ Quantity (0)

The excess demand is Q1-Q and Q1 ranges from 0 to infinity , at particular demand above the supply given by Q , the excess demand is given by [Q1-Q]

c.

Price($) (51lunmuend

Observe the curve , as the fuel expense and the taxes rises the demand curve shifts towards the left side i.e there is a change in demand , less demand for the same quantity demanded , therefore the rise in fuel costs and taxes reduces the excess demand .

d.

Price ($) (silun uuend

Now here the supply curve shifts towards the right and we see that the supply has increased for the same price levels i.e with building more roads the congestion reduces as the excess demand can be met by the excess supply till the point where the demand exceeds the supply.

If more individuals were encouraged to drive more the demand curve would shift upwards and the demand would increase thus the excess demand would increase and thus again congestion would increase .