SOLUTIONS TO SELF-CHECK QUESTIONS
3.1 Changes in Equilibrium Price and Quantity: The Four-Step Process
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- Step 1: Draw the graph with the initial supply and demand curves. Label the initial equilibrium price and quantity.
- Step 2: Did the economic event affect supply or demand? Jet fuel is a cost of producing air travel, so an increase in price affects supply.
- Step 3: An increase in the price of jet fuel caused an increase in the cost of air travel. We show this as an upward or leftward shift in supply.
- Step 4: A leftward shift in supply causes a movement up the demand curve, raising the equilibrium price of air travel and lowering the equilibrium quantity.
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- Step 1: Draw the graph with the initial supply and demand curves. Label the initial equilibrium price and quantity.
- Step 2: Did the economic event affect supply or demand? A tariff is treated like a cost of production, so this affects supply.
- Step 3: A tariff reduction is equivalent to a decrease in the cost of production, which we can show as a rightward (or downward) shift in supply.
- Step 4: A rightward shift in supply causes a movement down the demand curve, lowering the equilibrium price and raising the equilibrium quantity.
3.2 Price Ceilings and Price Floors
- A price ceiling (which is below the equilibrium price) will cause the quantity demanded to rise and the quantity supplied to fall. This is why a price ceiling creates a shortage.
- A price ceiling is just a legal restriction. Equilibrium is an economic condition. People may or may not obey the price ceiling, so the actual price may be at or above the price ceiling, but the price ceiling doesn’t change the equilibrium price.
- A price ceiling is a legal maximum price, but the market will choose the equilibrium price as long as the latter is below the former. In other words, a price floor below equilibrium will have no effect.
3.3 Consumer Surplus, Producer Surplus, and Deadweight Loss
- The consumer surplus is the extra benefit consumers receive from buying a good or service, measured by what the individuals would have been willing to pay minus the amount that they actually paid. The consumer surplus is illustrated on the demand and supply below in the area labeled F, which is the area above the market price and below the demand curve.
- The producer surplus is the extra benefit producers receive from selling a good or service, measured by the price the producer actually received minus the price the producer would have been willing to accept. The producer surplus is illustrated in the demand and supply diagram below in the area labeled G, which is the area between the market price and the segment of the supply curve below the equilibrium.
- Total surplus is the sum of consumer surplus and producer surplus. It is also referred to as economic surplus or social surplus. The total surplus in the demand and supply diagram below would be shown as the area F + G because the total surplus is the sum of the consumer surplus (F) and the producer surplus (G).