Question

(dollars per gallon) Production ...quota - ES 10 20 0 e 30 40 50 60 Quantity (thousands of gallo S 4) Based on the figure above, a. What is the free-market equilibrium price? b. What is the price after the government starts implementing the production quota? c. What is the consumer surplus after the production quota? d. Calculate the change in the total producer surplus after the production quota, and based on your finding, explain if the producers are better off or worse off as a result of this quota?

Answer 1

4) a. Free market equilibrium price is the price at which the demand and supply curve intersects that is at point A in the above figure. So price at point A is $3. Hence, the free market equilibrium price is $3.

b. We can see the production quota line which is set at quantity 20 thousands of gallon. At this quantity the price the consumer are willing to pay which is depicted by demand curve will be the price at production quota. So the point B shows the demand price at the production quota quantity. The price is $5. Hence, price after the government implements production quota is $5.

c. Consumer surplus is depicted by the area above the price line and below the demand curve.

As after production quota is implemented the price line is at $5. So the area between this price line and the demand curve is the area of the triangle with corners as point B, $5 and $7.

Area of Triangle = 1/2 * Base * Height = 1/2*(20-0)*(7-5)

= 1/2*20*2

= $20

Hence, Consumer Surplus after production quota is $20.

d. Producer surplus is depicted by the area above the supply curve and the price line.

Producer surplus before production quota or at free market is equal to area between free market price line i.e. at $3 and the supply curve.

Producer surplus after production quota is implemented is equal to area between free market price line i.e. at $5 and the supply curve but this area is only upto the the production quota line of production.

So, Change in Producer surplus after production quota is implemented :- Firstly there is a loss of producer surplus depicted by the triangular area ACE. Secondly there is a gain of producer surplus depicted by the area enclosed by points B, C, $3 and $5.

So, We add the gain in area and subtract the loss in area to find the overall change.

Change in Producer surplus = {(20-0)*(5-3)} - {1/2*(40-20)*(3-2)}

= {20*2} - {1/2*20}

= 40 - 10

= $30

Hence, There is an increase in producer surplus by $30.

As the change is positive or there is an increase in producer surplus so the producer's are better off as a result of this quota.

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