Question

The U.S. Automobile Manufacturers Association needs to predict what will happen to price and output of U.S. manufactured automobiles under the conditions stated below. Consider that you have been hired to study the market and provide predictions on how the events specified will affect the market (equilibrium) price and quantity of automobiles traded. What are your predictions? Discuss and illustrate each answer with supply and demand diagram (sketch). Assume that the market for automobiles is perfectly competitive (price and output are determined only by demand and supply).   

draw a sketch of the graphs electronically, you can submit scanned version of your manually drawn graphs.

          a. A stock market boom raises people’s wealth.

          b. Prices of comparable cars made in China decrease.

Answer 1

a. A stock market boom raises people’s wealth.

People will therefore feel rich and demand luxury. Automobiles being a luxury, will be demanded more. Since there is a change in the factors other than the price, demand curve will exhibit a shift to the right. This shift will raise the equilibrium price and quantity of automobiles traded

b. Prices of comparable cars made in China decrease.

Comparable cars are substitutes so a decline in their price will increase their quantity demanded. People will switch from US manufactuerd cars to cars made in China. This implies that demand curve will exhibit a shift to the leftt. This shift will reduce the equilibrium price and quantity of automobiles traded