Econ1220 Assignment 2 Question 4 with Solution:

Use the graph provided at the end of the assignment in answering this question.

The market for Widgets is perfectly competitive and is described by the following Inverse Demand and
Supply functions (these are “inverse” since Price is a function of Quantity, whereas the Demand and
Supply functions are written for Quantity as a function of Price):

Inverse Demand: P = 800 – 10QD

where P is the price in $/unit and QD is the quantity demanded in units per month.

Inverse Supply: P = 200 + 5QS

where P is the price in $/unit and QS is the quantity supplied in units per month.

A) Using the graph below on page 4, represent the information on the market for Widgets in a properly
labelled supply-demand diagram (make sure the diagram is drawn according to the exact functional
forms above!).

B) What are the equilibrium Price and Quantity in this market? (Use math and show calculations. Also,
don't forget the units).

C) At what prices is there a surplus in this market?

D) At what prices is there excess demand in this market?

E) What is the quantity of excess demand at a price of $300/unit?

Answer:

A) See Diagram Below. NOTE that the units of measure are included on the axis in brackets
and that this figure is labeled using full words (i.e. no shorthand is used, for example, it
says Price not “P”). You will lose marks for not fully labeling your diagrams when it is
stated that you have to “properly label” them.

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B) Take a look at the diagram. What you notice is that at the equilibrium price, P*, the Quantity
Demanded equals the Quantity Supplied (Equilibrium price is the price which equates the
Quantity Demanded with the Quantity Supplied; where the Demand and Supply curves
cross/intersect – it looks to be $400/unit, but we shouldn’t rely on the diagram in this case for our
answer, the math is more accurate).

In mathematical terms, we can state that at the equilibrium price, P*, QD = QS = Q*, where Q*
denotes equilibrium Quantity.

Using the stuff in the last paragraph and the original equations we know that when this
market is in equilibrium:

P* = 800 – 10Q*
P* = 200 + 5Q*

Since the first equation and the second equation both now equal P*, they must also equal each
other. (quick sidebar, this is like saying 6 = 4 + 2 and 6 = 5 + 1, so 4 + 2 = 5 + 1). Since the
equations both equal P8, we can write: 800 – 10Q* = 200 + 5Q*

We just need to rearrange (using the mathematical rules for rearranging) and solve for Q*…… to
get Q* = 40

Something like 800 – 10Q* - 200 = 200 + 5Q* - 200

600 – 10Q* = 5Q*
600 – 10Q* + 10Q* = 5Q* + 10Q*
600 = 15Q*
600÷15 = 15Q*÷15
40 = Q*

If we have done this correctly, plugging 40 into the two equations for P* should give the same
value for P*. This is the equilibrium Price we are asked to find……. So:

P* = 800 – 10Q* = 800 – 10×40 = 800 – 400 = 400 ; and

P* = 200 + 5Q* = 200 + 5×40 = 200 + 200 = 400

Now we have to remember to answer the question being asked! So we would close this off by
stating that equilibrium quantity is 40 units per month and the equilibrium price is $400/unit.

Please note that for any other price than $400/unit, the quantity demanded will not equal the
quantity supplied.

C) For this one you should have asked yourself, “what is a surplus?”. Please be careful to notice
that this surplus is not “economic surplus”, which has a different meaning. A surplus results
when, at a particular price, the Quantity Demanded is less than the Quantity Supplied. In our
standard Supply-Demand diagram, when is this true? For all prices above the equilibrium price!
So in this question, at all prices greater than $400/unit, there will be a surplus.

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D) Excess Demand is the same thing as a shortage. Excess Demand exists when, at a particular
price, the Quantity Demanded is greater than the Quantity Supplied. In this question, this is true
at any price below $400/unit. In general we would say that Excess Demand exists at prices
below the equilibrium price.

E) Here, we need to figure out the difference between the quantity demanded and the quantity
supplied at the price of $300/unit. We know that there is excess demand from the fact that the
equilibrium price is $400/unit, and that at prices below the equilibrium price, there is excess
demand. To calculate the quantity demanded, we use the inverse demand equation (P = 800 –
10QD) and solve for QD. This works out to be 50 units per month. To calculate the quantity
supplied, we use the inverse supply equation (P = 200 + 5QS) and solve for QS. This works out
to be 20 units per month. The excess demand is equal to the difference between the quantity
demanded and quantity supplied and, therefore, is 50 – 20 = 30 units per month.

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