Question

Draw supply-and-demand diagrams for market \(A\) for each of the following. Then use your diagrams to illustrate the impact of the following events. In each case, determine what happens to price and quantity in each market. a. \(A\) and \(B\) are substitutes, and the price of good \(B\) rises. b. \(A\) and \(B\) satisfy the same kinds of desires, and there is a shift in tastes away from \(A\) and toward \(B\). c. \(A\) is a normal good, and incomes in the community increase. d. There is a technological advance in the production of good \(A\) e. \(B\) is an input used to produce good \(A\), and the price of \(B\) rises.

Short answer

In case of substitute goods (Step 1) and a normal good with an income increase (Step 3), both price and quantity will increase for good \(A\). But if tastes shift towards \(B\) Step 2, the price and quantity of \(A\) will decrease. A technological advance in the production of \(A\) (Step 4) leads to a decrease in price but increase in quantity. Lastly, if the price of \(B\) increases being an input for \(A\) (Step 5), price will increase but quantity will decrease for \(A\).

Step-by-step solution

Substitutes goods - price rise

In the case of substitute goods like \(A\) and \(B\), if the price for \(B\) increases, the demand for \(A\) will also increase. Consequently, the demand curve will shift to the right i.e., upward. As a result, both the price and quantity of \(A\) will increase.

Same-desire goods - shift in taste

If both \(A\) and \(B\) serve similar desires, and consumers’ taste shift away from \(A\) towards \(B\), the demand for \(A\) will decrease. Consequently, the demand curve shifts to the left i.e., downward. This leads to a decrease in both the price and the quantity of \(A\).

Normal good - income increase

A good is called a normal good if the demand for it increases when people's incomes increase. Therefore, an increase in the community's income leads to an increase in the demand for \(A\), shifting the demand curve to the right i.e., upward. In turn, both the price and the quantity of \(A\) will increase.

Technological advance - production of \(A\)

A technological advancement that improves the production of \(A\) increases the supply of \(A\), shifting the supply curve to the right i.e., downward. This results in a decrease in price and increase in the quantity of \(A\).

Input price affect - price rise for \(B\)

If \(B\) is a raw material used in the production of \(A\), and the price of \(B\) rises, then the cost of producing \(A\) also goes up. Consequently, the supply of \(A\) decreases, the supply curve shifts to the left i.e., upward, which leads to an increase in the price and decrease in the quantity of \(A\).

Key concepts

Substitute Goods

Substitute goods serve similar purposes or satisfy the same need, meaning that if one becomes more expensive, consumers are likely to switch to the other. For instance, if tea (good A) and coffee (good B) are substitutes, and the price of coffee increases, more people will buy tea, increasing its demand.

In supply-and-demand diagrams, this situation is represented by the demand curve for tea shifting to the right. This shift indicates higher demand at every price level, which typically results in both a higher equilibrium price and quantity for tea. It's crucial for students to understand that the availability and pricing of substitute goods can significantly affect market dynamics.

Normal Good

A normal good is one for which demand increases as consumer incomes rise. This contrasts with an inferior good, whose demand decreases as incomes increase. For instance, high-quality electronics are often considered normal goods.

When a community experiences an income boost, the demand for these normal goods climbs, causing a rightward shift in the demand curve on the diagram. This increase in demand leads to a higher equilibrium price and quantity, reflecting the tempered purchasing power. It's imperative for students to recognize how economic changes in the wider community can directly affect consumer purchasing behavior and demand for normal goods.

Technological Advances in Production

Technological progress in manufacturing can have profound impacts on supply. It typically makes production more efficient, reducing production costs, and can often lead to an increase in the supply of a good.

On supply-and-demand diagrams, this is shown by a rightward or downward shift in the supply curve, meaning more goods can be supplied at each price level. The result is a lower equilibrium price due to the greater efficiency but an increased quantity of the goods sold. Students should understand that technological advances are pivotal for increasing supply and driving down costs.

Shifts in Consumer Tastes

Consumer tastes and preferences are not static; they can shift due to trends, advertising, or changes in societal values. Such shifts can lead to increased or decreased demand for certain goods.

When tastes shift away from a product, its demand curve shifts to the left, leading to a lower price and quantity equilibrium. Conversely, if preferences shift favorably towards a product, its demand curve shifts right, raising both price and quantity equilibrium. It's beneficial for students to analyze how cultural and social factors can significantly alter consumer behavior and market outcomes.

Input Prices Effect on Supply

The cost of inputs, or raw materials, is a crucial factor in production. If the price of an input rises, the cost of producing the final good typically increases as well.

In supply-and-demand diagrams, a rise in input costs will shift the supply curve to the left, showing a decrease in supply at every price level. This supply contraction raises the equilibrium price but lowers the quantity. Students need to grasp the intricate link between input costs and supply levels — and how businesses might respond to these cost changes.