--%>
Assignment Help - homework help

Problem on free market economy

A) Using appropriate tables and diagrams explain how price and quantity is determined in a free market economy.

B) Briefly explain using the diagrams in 4.1 the followings two scenarios

C) When price is set below the equilibrium price and

D) When price is set above the equilibrium price.

E

Expert

Verified

The law of demand and supply illustrates how a free market economy functions. The law of demand states that an increase in prices will decrease the quantity demanded in a free market economy and the law of supply states that an increase in prices will increase the quantity supplied in a free market economy. The price at which the quantity supplied and the quantity demanded is equal is the market equilibrium price. The quantity represents the market equilibrium quantity. A free market economy is one system, which tries to solve the basic economic problems through minimum governmental regulation and control. Hence in a free market economy, the prices and quantities tend to move towards the market equilibrium levels and keep the market stable in such a way. This can be illustrated by the following quantity demanded, supplier and prices of gasoline, for example:

275_ques3.jpg

From the above values, a graph can be plotted for the demand and supply curve as below.

2372_ques4.jpg

In order to determine the price and quantity of gasoline in the market, it is necessary to determine the price point where the demand equals the amount that suppliers are ready to supply. In the above example, at $1.25 per liter, demand exceeds supply and hence there will be a shortage of gasoline. Shortage most likely will drive up the prices since consumers compete to buy the product. When the price increases, demand decreases, since consumers go for substitutes. In such a case, supply will exceed demand and result in a surplus of gasoline, thus leading to a decrease in price levels. Finally, the market reaches its equilibrium point where the quantity supplied is equal to quantity demanded and the market will stabilize at this point. We can hence determine the equilibrium point by plotting a graph between quantity in the x-axis and price in the y-axis. Both the demand and supply curves must be drawn and the point of intersection of the demand and supply curve is the equilibrium point. In the above case, the equilibrium price is $1.5 per liter and the equilibrium quantity is 75 liters.

When price is set at $1 per liter (below equilibrium price), the shortage will drive up the price until it reaches $1.5 per liter. In this scenario, the demand will be high since consumers’ competition increase.

When price is set at $2 per liter (above equilibrium price), the surplus will drive down the price until it reaches $1.5 per liter. In this scenario, supply will be higher than demand since there will be more production but no consumption.    

   Related Questions in Microeconomics

  • Q : Implicitly weigh marginal cost and

    implicitly weigh marginal cost and marginal benefit

    		•
  • Q : Find price elasticity of demand for

    Suppose yearly steel sales double to 80 million tons while the price falls $40 per ton, to $180 per ton. Therefore price elasticity of demand for steel is approximately: (w) 3.333. (x) 10.000. (y) 2.500. (z) 6.667.

    Q : Dilemma on labor monopsonist The labor

    The labor monopsonist will hire labor up to the point where the marginal: (i) Revenue product of the labor equivalents the wage. (ii) Resource cost of labor equivalents the salary. (iii) Revenue product of labor equivalents its marginal resource cost. (iv) Resource co

    		•
  • Q : Probability of Law of Diminishing

    Can someone help me in finding out the right answer from the given options. Karina gets 27 utils from her first ice-cream cone in an hour, and 23 extra utils from the second that hour. Determine the number of utils is she likely to obtain from the third cone? (i) 15 u

    		•
  • Q : Long-run supply curve of a purely

    Long-run supply curve of a purely competitive industry has a slope which is: (w) negative to offset the positive slope of each firm’s short-run supply. (x) positive to reflect the positive slope of each firm’s short-run supply. (y) depende

    		•
  • Q : Price ceiling set below equilibrium A

    A price ceiling set below equilibrium will raise the: (w) quantity supplied. (x) good’s opportunity cost to buyers. (y) sellers’ profits. (z) rate of excess supply. How can I solve my economics

    		•
  • Q : Characteristics of Entrepreneurship The

    The Characteristics common to most of the successful entrepreneurs do not comprise: (1) Vision and timing. (2) Conviction and action. (iii) Luck and the bureaucratic one-upmanship. (iv) Determination and workaholics. Can someone pl

    		•
  • Q : Price ceilings and price floors Price

    Price ceilings and price floors: 1) cause surpluses and shortages respectively. 2) make the rationing function of free markets more efficient. 3) interfere with the rationing function of prices. 4) shift demand and supply curves and therefore have no effect on the rat

    		•
  • Q : Quintile distribution of income Give

    Give the answer of following question. In the quintile distribution of income, the term "quintile" represents: A) 5 percent of the income receivers. B) 10 percent of the income receivers. C) 20 percent of the income receivers. D) 25 percent of the income receivers.

    		•
  • Q : Farm maximizes profit of producing at

    When the wholesale price P = $3 per dozen increased, this purely competitive increased farm maximizes profit with producing ___ dozen increased at a total (loss or profit) of $___. (i) zero; loss; $2000. (ii) 2000; loss; $1500. (iii)

    		•