Question

Suppose the market for gas-powered generators in Moscow is originally described by the equations P = 1000 – 5QD and P = 200 + 3QS. This means the market is in equilibrium with a price of $500 and a quantity of 100 generators. Now suppose that climate change exists and an unprecedented ice storm takes hold in the region. As a result the new demand for generators is given by the equation P = 1400 – 5QD.

Suppose that Latah County had predicted that an ice storm (or other extreme weather event) was going to take place. As a result, they passed a law saying prices cannot increase by more than 12% after a severe weather outbreak. This means the price of generators cannot be higher than $560. Use the equations to solve for the market outcome if this law is in place. Explain the outcome briefly in words, sketch and label a graph of the situation.

Answer 1

According to the new law passed,the price cannot exceed $560.

So in our graph below,we show this constraint by a horizontal line at p = 560. At this price,the quantity supplied is denoted by point A at which Q = 120, and the quantity demanded is Q = 168. We got these values by plugging in P = 560 in the supply and new demand equation. Clearly at the price set by the law, there is excess demand of 48 units (i.e 168 -120 ).