Question

Exercise 1. Label each of the follow scenarios with the correct combination of price change and quantity change. In some scenarios, it may not be possible from the information given to determine the direction of a particular price change or a particular quantity change. We will symbolize those cases as, respectively, “P?” and “Q?” For each part also draw two graphs to illustrate the changes (one graph will reflect the changes in Demand and the other will reflect the changes in Supply). Carefully explain your final answer for each part. (60 points) P↓ Q? P? Q↓ P↑ Q? P? Q↑ a. On a cloudy day, both the demand for lemonade and the supply of lemonade decrease. P? Q↑- We do not know the change in price because when demand decreases, P and Q both decrease, when supply decreases P decreases but Q increases. In both cases P decreases but Q is in opposite direction. We do not know which one shifted more causing a Q? b. On a hot day, both the demand for ice cream and the supply of ice cream increase. P? Q↓- c. When Hawaii’s Mt. Kiluea erupts violently, the demand on the part of tourists for sightseeing flights increases but the supply of pilots willing to provide these dangerous flights decreases. P↑ Q? d. In a hot area of Arizona where they generate a lot of their electricity with wind turbines, the demand for electricity falls on windy days as people switch off their air conditioners and enjoy the breeze. But at the same time, the amount of electricity supplied increases as the wind turbines spin faster.

Answer 1

a) When demand decreases price and quantity decreases. Decrease in supply increases price and decreases quantity. Thus the net result depends on the magnitude of shift of demand and supply curve. In all cases quantity will decrease.

b) Increase in demand causes prices and quantity to increase. Increase in supply causes price to fall and quantity to increase. Thus the net effect on price is ambiguous while quantity is sure to increase.

c) Decrease in demand causes decrease in price and quantity. Increase in supply causes decrease in price and increase in quantity. Thus price decreases in all the three cases while change in quantity depends on the magnitude if change.