What is the size of the surplus or shortage?
Demand for gas (in 1000 gallons) can be represented by the equation Pd= 12.23-1.4Q. Gas is currently selling at $3.95/gallon but the government thinks there is evidence of price gouging and wants the price capped at $3.49/gallon. The supply curve has a slope of 1.0. What is the size of the surplus or shortage which will emerge if the government gets its wish?
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The demand curve for gas (in 000) is Pd = 12.23 - 1.4*Q
At $3.95/gallon, the demand for gas is 12.23 - 1.4*3.95 = 6700 gallons
At $ 3.49/gallon, the demand for gas is 7344 gallons.
The supply of gas follows a curve with a slope 1. If the price decreases by x, the amount supplied decreases by x*1000 gallons.
When the price of gas is capped at $3.49/gallon, there is a decrease of $0.46 from the equilibrium price. This reduces the quantity supplied by 460 gallon. As there is an increase in demand of 7344 - 6700 = 644 gallons and the supply decreases by 460 gallons, the shortage of gas is 1104 gallons. This clearly illustrates the fact that imposing a price cap on a good at a price level below the equilibrium price creates a shortage of the good in a free market.
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