Question

What effect will each of the following have on the demand for small cars such as the Mini Cooper and Fiat 500?

a. Small cars become more fashionable.

b. The price of large cars rises (with the price of small cars remaining the same).

c. Income declines and small cars are an inferior good.

d. Consumers anticipate that the price of small cars will decrease substantially in the near future.

e. The price of gasoline substantially drops.

Short answer

1. Demand will increase.

2. Demand will increase.

3. Demand will increase.

4. Demand will decrease.

5. Demand will increase.

Step-by-step solution

Effect of consumer’s taste and preferences on the demand for small cars

If a good becomes fashionable, a consumer’s taste and preference change towards that good. A preference for a good increases the demand for that good. Hence, when small cars become the new fashion, the consumers will demand more small cars.

Effect of a rise in the price of large cars on demand for small cars

Large cars and small cars are substitute goods. A rise in the price of large cars will reduce the demand for large cars as per the law of demand. At the same time, it will encourage the consumers to shift their demand to small cars, which are now relatively cheaper. Thus, the demand for small cars will increase.

Effect of income on demand for an inferior good (small cars)

Inferior goods have a negative relation with the income of the consumer. A fall in income encourages consumers to shift their demand from normal goods to inferior goods. The inferior goods are relatively poorer quality goods. A fall in income means lower purchasing power that makes good quality products unaffordable, and hence relatively poorer quality products replace their consumption. Thus, the demand for small cars which are treated as inferior goods will increase when the consumer’s income decreases.

Effect of consumer expectations on demand for small cars

If a consumer expects that the price of small cars will decline in the future, he/she will shift the consumption to the future and will demand fewer small cars in the current period. Thus, the demand for small cars will decrease based on the expectation of a fall in future prices.

Effect of a decrease in the price of gasoline on demand for small cars

Small cars need gasoline to run. Thus, these two goods are complements because both are demanded together. The demand for one depends on the demand for the other. If the price of gasoline declines, its demand will increase, and so will the demand for small cars.