Suppose that, starting from a perfectly competitive market, the government introduces a binding production quota assuming that the laws of demand and supply hold.

The price elasticity of demand at the equilibrium has no effect on the magnitude of the change in price due to the production quota.

Question

Suppose that, starting from a perfectly competitive market, the government introduces a binding production quota assuming that the laws of demand and supply hold.

The price elasticity of demand at the equilibrium has no effect on the magnitude of the change in price due to the production quota.

BlackTom AI · Accepted Answer

This question asks whether imposing a binding production quota in a perfectly competitive market, while assuming demand and supply laws hold, leaves the magnitude of the price change independent of the price elasticity of demand at the equilibrium.
Option 1 (True): If we stated that the elasticity of demand at the equilibrium has no effect on how much the price changes when a quota is imposed, we would be ignoring a core result from monopoly/quota analysis. In a competitive market with a binding quota, the upper limit on quantity causes a price adjustment determined in part by how responsive buyers are to price changes. If demand is more elastic, buyers reduce quantity demanded more as price rises, which tends to amplify or attenuate the price impact differently than with inelastic demand. Therefore, the claim that elasticity does not affect the magnitude of the price change is incorrect.
Option 2 (False): The correct stance is that the price change created by a production quota does depend on the price elasticity of demand. The provided diagram and supporting notes describe how the more elastic the demand relative to supply, the smaller the price increase (and larger deadweight adjustments) vs. when demand is inelastic. Specifically, the deadweight loss and the wedge between the quota-driven price and the free-market price are functions of how sensitive quantity demanded is to price changes (elasticity). Hence elasticity at the equilibrium matters for the size of the price change induced by the quota.
Additional clarification: In a binding quota, the quantity is restricted to Q_new, which shifts the intersection of supply and demand and creates a price difference P* vs. P_equilibrium. The extent of this price gap depends on how strongly consumers respond to price—that is, the elasticity of demand. A more elastic demand reduces the incentive to raise price as much, while a more inelastic demand allows a larger price increase with the same quota. The accompanying reasoning notes that the deadweight loss component A (the wedge is influenced by elasticity) demonstrates that elasticity shapes the outcome, not a universal, elasticity-free change.
Thus, the statement is false because elasticity of demand at the equilibrium does affect the magnitude of the price change caused by a binding production quota.

SIPAIA6400_001-002_2025_3 - Microeconomic Analysis for International and Public Affairs Problem Set 2, Individual Portion

Suppose that, starting from a perfectly competitive market, the government introduces a binding production quota assuming that the laws of demand and supply hold. The price elasticity of demand at the equilibrium has no effect on the magnitude of the change in price due to the production quota.

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