Question

Include correctly labeled diagrams, if useful or required, in explaining your answers. A correctly labeled diagram must have all axes and curves clearly labeled and must show directional changes. If the question prompts you to “Calculate,” you must show how you arrived at your final answer.

Assume gadgets are sold in a competitive market, the equilibrium price is $6, and the equilibrium quantity is 500 units.

(a) Using the numerical values above, draw a correctly labeled graph of the market for gadgets and show each of the following.

(i) The equilibrium price

(ii) The equilibrium quantity

(b) At a price of $8 per unit, will there be a surplus or a shortage in the market? Explain.

(c) Assume gadgets now become more popular. On your graph in part (a), show the effect of the increase in gadgets' popularity on the equilibrium price and quantity of gadgets.

(d) Assume instead there is an increase in the price of tin, a major input in producing gadgets. What will be the effect of an increase in the price of tin on the market for gadgets?

(e) If both changes in part (c) and part (d) occurred simultaneously, will the equilibrium quantity of gadgets increase, decrease, remain unchanged, or be indeterminate? Explain.

Answer 1

a) At a price of $6 and quantity of 500 units, the graph will be:

  

At this market equilibrium, market demand will be 500 units and equilibrium price will be $6.

b) At the price of $8 per unit, there will be surplus in the market. This is because, higher prices will stimulate higher levels of production, but it will discourage buyers from buying, so that will decrease the demand. That is, while supply increases, demand decreases. There will be more goods available, but less takers. The result is surplus of goods available in the market.

c) When gadgets become more popular, it results in an increased demand. This pushes the price upwards. That is, price increases. With a higher price now, the producers have an incentive to produce more with the aim of earning more profits. Thus, both equilibrium price and quantity increase.

d) When there is an increase in the input price (tin), the cost of production increases, pushing the price higher. So producers have less incentive to sell goods at the given price. This effect is seen in the supply curve moving to left, and meets the demand curve at a level where price is higher and quantity lower. In other words, when input price increases, equilibrium quantity decreases and price increases.

e) When both the events take place simultaneously, the resulting quantity is indeterminate. This is because of the extent of interaction of demand and supply curves. This is because this situation is an interaction of demand and supply curves. Demand curve is moving to the right (demand increases; as in c) while supply curve is moving to the left (supply decreases as in d). If the movement of demand curve is proportionately more than that of supply curve, it means there is more demand than supply. Equilibrium quantity will increase. But, if the movement of demand curve is proportionately less than that of supply curve, then there is more supply than demand. Equilibrium quantity decreases. Hence the resulting quantity is indeterminate.