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Economic Theory

2. Suppose that the equation for a demand function is given by
P = A + b*Qd, and the supply function is given by P = C + d*Qs, where
the * denotes multiplication. Further, at equilibrium, Qd = Qs = Q, where
Qd = Quantity demanded and Qs = Quantity Supplied, and Q is the

quantity that clears the market. Assume that A = 40, b = –2, C = 0, d = 1,5,
and assume that Q goes from 0 to 20.

2.1. On a sheet of paper, algebraically solve this system of equations
for the equilibrium price and quantity, that is, the equilibrium point where
Qd = Qs = Q, and calculate this value on your spreadsheet. What value is
Q at this point? What value is P?

2.2. Use a spreadsheet chart to graph the demand and supply
functions above and identify the market-clearing equilibrium.
2.3. Calculate the amount of excess demand or excess supply at

prices other than the price at which the market is cleared. At a price of
$18, is there excess demand or excess supply? How much? At a price of
$6 is there excess demand or excess supply? How much? Hint, at any
given price, the disequilibrium quantity is the difference between the

quantity supplied and the quantity demanded (that is, Qs – Qd) for this
specific price. If this difference is positive, then there is excess supply. If
the difference is negative, this means that at a specific price there is excess

or unsatisfied demand at that price.
Now assume that there has been a shift in demand at all prices due to
some exogenous factor such as an increase in real family income levels.
Assume that the A parameter or demand price axis intercept has suddenly

increased from 40 to 50.
2.4. Draw a graph that shows the old demand, the new demand and the

supply function. Calculate the new market equilibrium price and quantity
on your spreadsheet, and show this new equilibrium on your graph.
2.5. Use a spreadsheet chart to graph the demand and supply functions
above and identify the market-clearing equilibrium.

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