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(Solution) - Governments often interfere in markets by placing restrictions on the

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Governments often interfere in markets by placing restrictions on the price that firms can charge. One common example of this is so-called ?anti-price gauging laws? that restrict profits for firms when sudden sup- ply shocks hit particular markets.
A: A recent hurricane disrupted the supply of gasoline to gas stations on the East Coast of the U.S. Some states in this region enforce laws that prosecute gasoline stations for raising prices as a result of natural disaster-induced drops in the supply of gasoline.
(a) On a graph with weekly gallons of gasoline on the horizontal and price per gallon on the vertical, illustrate the result of a sudden leftward shift in the supply curve (in the absence of any laws governing prices.)
(b) Suppose that gasoline is a quasilinear good for consumers. Draw a graph similar to the one in part (a) but include only the post-hurricane supply curve (as well as the unchanged demand curve). Illustrate consumer surplus and producer profit if price is allowed to settle to its equilibrium level.
(c) Now consider a state that prohibits price adjustments as a result of natural disaster-induced supply shocks. How much gasoline will be supplied in this state? How much will be demanded?
(d) Suppose that the limited amount of gasoline is allocated at the pre-crisis price to those who are willing to pay the most for it. Illustrate the consumer surplus and producer profit.
(e) On a separate graph, illustrate the total surplus achieved by a social planner who insures that gasoline is given to those who value it the most and sets the quantity of gasoline at the same level as that traded in part (c). Is the social surplus different than what arises under the scenario in (d)?
(f) Suppose that instead the social planner allocates the socially optimal amount of gasoline. How much greater is social surplus?
(g) How does the total social surplus in (f) compare to what you concluded in (b) that the market would attain in the absence of anti-price gauging laws?
(h) True or False: By interfering with the price signal that communicates information about where gasoline is most needed, anti-price gauging laws have the effect of restricting the in- flow of gasoline to areas that most need gasoline during times of supply disruptions.
B: Suppose again that the aggregate demand function XD (p) = 250, 000/p2 arises from 10,000 local consumers of gasoline with quasilinear tastes (as in exercise 15.8).
(a) Suppose that the industry is in long run equilibrium ? and that the short run industry supply function in this long run equilibrium is XS (p) = 3, 906.25p. Calculate the equilibrium level of (weekly) local gasoline consumption and the price per dollar.
(b) What is the size of the consumer surplus and (short run) profit?

(d) What is the sum of consumer surplus and (short run) profit if the market is allowed to adjust to the new short run equilibrium?
(e) Now suppose the state government does not permit the price of gasoline to rise above what you calculated in part (a). How much gasoline will be supplied?
(f) Assuming that the limited supply of gasoline is bought by those who value it the most, calculate overall surplus (i.e. consumer surplus and (short run) profit) under this policy.
(g) How much surplus is lost as a result of the government policy to not permit price increases in times of disaster-induced supply shocks?


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