Grasping Reality on TypePad, by Brad DeLong

In the central part of the state of Euphoria there is a small city, Avicenna, which is the home of Euphoric State University. [“Avicenna” is a corruption of the Arabic Ibn Sina, the byname of the great eleventh-century Iranian Abu Ali al-Husayn ibn Abd Allah ibn Sina: academic administrator, Quran reciter, astronomer, chemist, geologist, psychologist, theologian, mathematician, physicist, physician, poet, and paleontologist.] We will look at the daily market for espresso-based drinks in Avicenna.

Suppose that the quantity of espresso drinks demanded and the quantity of espresso drinks supplied daily are given by the equations:

• Demand: Q = 20,000 - 2000P
• Supply: Q = max(-16000 + 8000P, 0)

where P is the price of an espresso-based drink in dollars:

1. What is the market equilibrium price?
2. What is the market equilibrium quantity?
3. What is the producer surplus?
4. What is the consumer surplus?
5. Explain, intuitively, why the distribution of producer and consumer surplus is what it is.
6. What would the distribution of consumer and producer surplus be if the supply equation were: P = 3.6?