The market of donuts is perfectly competitive in Kansas City. The daily demand f
ID: 1195567 • Letter: T
Question
The market of donuts is perfectly competitive in Kansas City. The daily demand for donuts in Kansas City is Q = 20,000 - 5,000P and the supply is Q = -4,000 + 10,000P (where Q is the quantity and P is the price of donuts). Draw the demand and supply curve.
Now answer the following questions assuming the city council of Kansas City imposes a price ceiling set as $1.20 per donuts sold in Kansas City (assume donuts are rationed to the highest-valued customers):
a) Does the price ceiling cause a surplus or shortage of donuts? What is the amount of surplus or shortage?
b) Calculate customer surplus under the price ceiling. Are donut customers better off with the price ceiling on donuts? Explain carefully.
c) Calculate the producer surplus under the price ceiling. Are Kansas City donut producers better off with the city's council's price ceiling on donuts? Explain carefully.
Explanation / Answer
First we calculate the equilibrium price and quantity of the donuts
At equilibrium demand = supply
20000 - 5000P = -4000 + 10000P
15000P = 24000
P = $1.6
Q = 20000 - 5000 x 1.6 = 12000
Price at which there will be no demand is 20000 - 5000P = 0
P = 20000 / 5000 = $4
Quantity demanded at the price ceiling of 1.2 = 20000 - 5000 x 1.2 = 14000
Quantity supplied at the price ceiling of 1.2 = -4000 + 10000 x 1.2 = 8000
Which means there is a shortage of 14000 - 8000 = 6000 donuts at the price ceiling of $1.2
Consumer surplus is the area under the triangle which has a base of 4 - 1.2 = 2.8 and the height of 14000. Hence consumer surplus under the price ceiling will be = 14000 x 2.8 / 2 = $19600
Producer surplus is the area under the triangle which has a base of 1.2 and the height of 8000. Hence producer surplus under the price ceiling will be = 8000 x 1.2 = $9600
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