Question 2: [11marks]

According to an article in China Daily, China recently accelerated its plan to privatize tens of thousands of state-owned firms. Imagine that you are an aide to a senator on the Foreign Relations Committee of the U.S. Senate, and you have been asked to help the committee determine the price and quantity that will prevail when competitive forces are allowed to equilibrate the market. The best estimates of the market demand and supply for the good (in U.S. dollar equivalent prices) are given by: Qd=12 -2P and Qs=-4 + 2P, respectively.

a.Determine the competitive equilibrium price and quantity. [3marks]

b.Based on your answer to the Senate Foreign Relations Committee in question (2a), one of the senators raises a concern that the free market price might be too high for the typical Chinese citizen to pay. Accordingly, she asks you to explain what would happen if the Chinese government privatized the market, but then set a price at the Chinese equivalent of $3.00. How do you answer? What name is given to the control price $3.00 and why? What is the full economic price for the product?[8marks]