Question 3 [5 marks]

1. 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 byQd=12 -4P and Qs=4 + 4P, respectively.

A.Determine the competitive equilibrium price and quantity.[ 1 mark]

B.Based on your answer to the Senate Foreign Relations Committee, 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 ceiling at the Chinese equivalent of $1.50. How do you answer this question? What is the full economic price for the product?[2 marks]

C.On the other hand, one of the members of the Senate Foreign Relations Committee has also studied your previous analysis of Chinese privatization but is worried that the free-market price might be too low to enable producers to earn a fair rate of return on their investment. He asks you to explain what would happen if the Chinese government privatized the market, but agreed to purchase the good from suppliers at a floor price of $8. What do you tell the senator?[2 marks]