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"The Chicago Fire of 1871 destroyed half the cubic contents of the city's buildings. The value of the surviving buildings after the fire probably exceeded the value of all the buildings before. True or False?"

Draw a supply and demand diagram for housing in Chicago and assume, for simplicity, a totally inelastic supply of housing both before and after the fire. Distinguish between the different concepts of value - value in use and value in exchange - and consumer surplus. What is the importance of the price of elasticity of demand?

How do I go about this question? I'm not really sure how to start and how to answer it.

Any help would be appreciated!

Thanks :)

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1 Answer

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Here's a good place to start:

Firstly, identify the supply + demand change to take place. The Chicago Fire of 1871 destroyed city buildings right? That will reduce the supply of housing. Do you know how to draw perfectly inelastic supply curves for housing? It affects the slope. Try to think conceptually what this means too (it has something to do with how quickly houses can be created again and sold in the marketplace).

Also, the different concepts of value - I've never heard of them, but this is my guess:

  • value in use = Willingness to pay (how much the consumer benefits from using the commodity)
  • value in exchange = The equilibrium price paid in the marketplace (where the exchange happened)

And of course: consumer surplus is simply value in use - value in exchange (i.e.: How much do I benefit from it, and how much do I have to pay for it? The gap is my "surplus", or how much I gain from the trade.)

Price elasticity of demand is a bit of a separate question to all this stuff, but you need to analyse how a different sloped demand curve would have affected the outcome of a fire.

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