Question

Cow milk and soy milk are substitute goods. Draw the graphs of the markets for cow and soy milk. Now, suppose production of cow milk becomes more costly to produce. What happens in the two markets? Show in the graphs and explain. (Denote the initial curves and equilibria by 1 and the new ones by 2.)

Answer 1

In each graph, D1 & S1 are initial demand & supply curves intersecting at point A with initial price P1 & quantity Q1.

When cow milk becomes costlier to produce, cow milk suppliers lower output, so supply falls, shifting supply curve leftward. This increases the price and decreases the quantity of cow milk as shown below. As S1 shifts to S2, it intersects D1 at higher price P2 and lower quantity Q2.

As cow milk becomes costlier, demand for soy milk, the substitute good, rises, shifting the demand curve rightward which leads to higher price and quantity of soy milk. In following graph, as D1 shifts right to D2, it intersects S1 at point B with higher price P2 and higher quantity Q2 of soy milk.