Question

Suppose that currently the market for gluten-free spaghetti is in long-run equilibrium at a price of \(\$ 3.50\) per box and a quantity of 4 million boxes sold per year. If the demand for gluten-free spaghetti permanently increases, which of the following combinations of equilibrium price and equilibrium quantity would you expect to see in the long run? Carefully explain why you chose the answer you did. a. A price of \(\$ 3.50\) per box and a quantity of 4 million boxes b. A price of \(\$ 3.50\) per box and a quantity of more than 4 million boxes c. A price of more than \(\$ 3.50\) per box and a quantity of more than 4 million boxes d. A price of less than \(\$ 3.50\) per box and a quantity of less than 4 million boxes

Short answer

The correct option would be b: A price of \(\$ 3.50\) per box and a quantity of more than 4 million boxes in the long run. This is attributed to the increase in demand leading to a short term increase in price, which then incentivizes suppliers to increase the quantity supplied. This eventually leads to a new equilibrium where the price returns to its original level but with a higher quantity.

Step-by-step solution

Understand the Current Market Condition

In this case, the market for gluten-free spaghetti is in a long-run equilibrium at a price of \(\$ 3.50\) per box and a quantity of 4 million boxes sold per year which implies supply equals demand at this price level.

Understand the Impact of Increased Demand

The demand for gluten-free spaghetti permanently increases. When demand increases and the supply remains the same, this will cause a temporary shortage, meaning more customers want the product than the market currently has to offer at the current price. This causes the price to increase in the short run.

Describe Long Run Adjustments

Since there is a higher price in the market now, suppliers will have an incentive to produce more gluten-free spaghetti. Over time, this will shift the supply curve rightwards until a new long-run equilibrium is reached where the quantity is more than before and the price is the same in the long run (since gluten-free spaghetti is a standardized product with free entry and exit of firms). Therefore in the long run, we would expect the market to adjust to match the higher demand. As a result, the quantity of goods sold would increase, but the price would return to its original level.

Choose Correct Option

Option (b) is correct - A price of \(\$ 3.50\) per box and a quantity of more than 4 million boxes, because the higher demand has led to an increase in quantity sold, but in the long run the price would return to its original level due to market adjustments.

Key concepts

Market Adjustments

In the context of economics, market adjustments refer to the dynamics by which a market returns to equilibrium, a state where the quantity supplied equals the quantity demanded, after experiencing some form of disruption. When the demand for a product, like gluten-free spaghetti, increases, the initial equilibrium is disturbed, leading to a shortage as the existing supply is insufficient to meet the heightened demand.

In the short term, this shortage typically results in a higher equilibrium price as suppliers can charge more due to the increased desire for the product. Consumers are willing to pay more to obtain the goods they desire, while producers react by increasing prices to maximize revenue. However, this change also signals producers to ramp up production to capitalize on the potential profits from the higher demand.

Over time, as more firms increase their output or new firms enter the market (due to minimal barriers to entry), the supply curve shifts to the right. This increase in supply, if persistent, tends to push prices back down toward the original equilibrium price as the market adjusts to the new level of demand. The key takeaway here is that market adjustments are a natural response to changes in demand or supply, leading to a new equilibrium.

Demand and Supply

Demand and supply are the core components of any market. Demand represents the quantity of a good or service that consumers are willing and able to purchase at various prices, while supply indicates the quantity that producers are willing and able to sell. When the market is in equilibrium, the quantity demanded equals the quantity supplied, resulting in an 'equilibrium price'.

The demand curve typically slopes downwards, suggesting that as price decreases, the quantity demanded increases. Conversely, the supply curve usually slopes upwards, indicating that a higher price leads producers to offer more of a product for sale.

When either demand or supply changes, the equilibrium is affected. For instance, an increase in demand for gluten-free spaghetti, as seen in the exercise, causes a rightward shift of the demand curve, leading to a higher equilibrium price and quantity in the short term. Conversely, a rightward shift in the supply curve, which might happen when existing firms expand production or new firms enter the market, can lead to a lower equilibrium price and a higher equilibrium quantity in the long term. These mechanisms underscore the importance of understanding how shifts in demand and supply can impact market outcomes.

Price Elasticity

Price elasticity of demand is a measure that describes how the quantity demanded of a good changes in response to a change in price. In technical terms, it is the percentage change in quantity demanded divided by the percentage change in price. Goods with a high price elasticity are considered to be 'elastic', meaning consumers will significantly reduce their quantity demanded if the price rises. On the other hand, goods with a low price elasticity are 'inelastic', and their quantity demanded doesn't change much with the price.

The concept of price elasticity is crucial when discussing market adjustments because it influences how consumers respond to changes in price due to shifts in demand or supply. In the case of gluten-free spaghetti, if demand is highly elastic, a temporary rise in price due to increased demand could cause a significant drop in quantity demanded. Meanwhile, if demand is inelastic, the quantity demanded would not decrease much even if the price rises. In long-run equilibrium, though, regardless of the product's elasticity, prices tend to stabilize as the market adjusts, assuming free entry and exit of firms and a standardized product.