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In June 2008, the U
In June 2008, the U.S. retail gas price jumped from $3 to $4 a gallon. This is a 33% increase in price from January 2008. During that time, the total quantity of gasoline purchased fell by 3%. Supplies of gasoline produced also decreased from 1 million barrels to 800,000 barrels. No viable substitute has been created to replace gasoline.
How do I calculate consumer and producer surplus from this info? I know its 1/2 x (price - optimal price) x quantity for consumer and 1/2 x price x quantity, but I don't know which numbers I should put where. Also, how should I calculate elasticity of demand? Should I use the 33% price increase or should I use the price change from 3 - 4? Please give as much detail as possible.
Expert Solution
We can use the general formula to calculate the Price elasticity of demand i.e responsiveness of change in quantity demanded to change in price.
Thus, price elasticity of demand: 3% / 33% = 0.09
Since there is a 33% increase in the price, we know that there is an inverse relationship between quantity demanded and price. Thus, as price increases, consumers will buy less of the commodity. On the contrary, producers are profit maximizers. They will produce more of the commodity as price increases. As more of the commodity is produced, this will lead to a surplus.
There isn't sufficient information given in the question to calculate the consumer and producer surplus. That is why explaining the difference or trend theoretically will be a wiser step.
If we were given the information on the equilibrium quantity and the equilibrium price then we could calculate it using the formula 1/2 x base x height, where base is the equilibrium quantity and height is the equilibrium price. Then, you can solve by equation the demand and supply function, which will help you calculate the consumer as well as the producer surplus respectively.
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