Question

The L.O.L. Surprise! Winter Disco Chalet was a very popular dollhouse during Christmas 2019. Originally its price was $240, but the manufacturer ran out. Some people who had already bought Winter Disco Chalets were willing to sell them on Amazon or eBay, so it was still possible to buy them, but the equilibrium price was $340. Suppose the equilibrium quantity in this market is 5000. (Note we would call this the "secondary market" since the sellers are not the original producers but instead people who are reselling them.) (a) Suppose that at the equilibrium shown in the graph, the price elasticity of demand is ed = −1.7. Explain whether demand is inelastic or elastic at the equilibrium. If the demand curve is linear, what is the equation for the demand curve?

(b) At the market equilibrium price and quantity, what is the consumer surplus and producer surplus. Use the letters on the diagram to give your answer, no need for numerical answers.
(c) Suppose a government law against price gouging prohibited sales at prices above the official retail price of $240. Explain whether you believe the quantity sold is now 2,500 or 7,500. Make sure to explain both why it is the amount you choose and why it is not the quantity you do not choose.
(d) How much deadweight loss is caused by the price gouging law? Give your answer both in terms of the letters on the diagram. Also describe in words what this deadweight loss represents.

Answer 1

Exp(a) The price elasticity of demand (ed) is -1.7, which means that demand is elastic at the equilibrium. A linear demand curve equation can be written as Qd = a - bp, where Qd is the quantity demanded, p is the price, a is the intercept, and b is the slope.

(b) Consumer surplus is represented by the area above the equilibrium price and below the demand curve (A+B), while producer surplus is represented by the area below the equilibrium price and above the supply curve (C).

(c) If a government law against price gouging prohibited sales above the official retail price of $240, the quantity sold would be 2,500. This is because at the price of $240, the quantity demanded is equal to the quantity supplied (equilibrium quantity), and any price above $240 would result in a surplus of Winter Disco Chalets. The quantity sold would not be 7,500 because there is not enough supply at the price of $240 to satisfy the quantity demanded.

(d) The deadweight loss caused by the price gouging law is represented by the area (D+E). This loss represents the inefficiency that occurs when the quantity demanded is less than the quantity supplied due to a price ceiling. In this case, the law causes a shortage of Winter Disco Chalets, meaning that some buyers who are willing and able to pay more than $240 for the toy are unable to obtain it, resulting in lost gains from trade.lanation: