Chapter 9, Problem 1CYU

To determine

The question requires us to identify the price of a rise, the quota rent, and the deadweight loss in the graph and determine the impact on quota rent and the deadweight loss.

Explanation of Solution

The following graph represents the supply-demand diagram with quota:

  

Here,

Without quota, the market is producing at point E where:

Equilibrium price = $5 per ride

Equilibrium quantity = 10 million rides

When the government sets the quota at 6 million rides,

a) The demand price = price of the ride = $7 per ride

The supply price = $3 per ride.

b) Quota rent = demand price − supply price = $7 − $3 = $4 per ride.

The colored area represents the deadweight loss in the market due to the quota.

  $\begin{array}{c}DWL=\frac{1}{2}\times 4\times \left[\left(7-5\right)+\left(5-3\right)\right]\\ =2\times 4\\ =8\end{array}$

The deadweight loss is $8 million.

d) When quota increases to 9 million rides:

  

When the government sets the quota at 6 million rides,

a) The demand price = price of the ride = $5.5 per ride

The supply price = $4.5 per ride.

b) Quota rent = demand price − supply price = $5.5 − $4.5 = $1 per ride.

The colored area represents the deadweight loss in the market due to the quota.

  $\begin{array}{c}DWL=\frac{1}{2}\times \left(10-9\right)\times \left[\left(5.5-5\right)+\left(5-4.5\right)\right]\\ =0.5\end{array}$

The deadweight loss is $0.5 million.

When the quota rises to 9 million rides, the deadweight loss and quota rent will fall.

Economics Concept Introduction

A quote puts an upper limit on the quantity sold or purchased in a market. Quota brings inefficiency in the market by generating a deadweight loss. The price of the ride will be the demand price. The price at which the consumers are willing to buy the rides is known as the demand price. The supply price is the price at which the producers are willing to accept or sell rides.

The difference between the supply price and the demand price represents the quota rent.