Question

Price Equilibrium and Quantity Equilibrium

Assume Economy Ashland produces Pepsi.

a) In the space provided below show the Pepsi market by graphing the coffee demand and supply curves. Label the Demand curve D1, Supply curve S1, Equilibrium point E1, Price Equilibrium P1, and Quantity Equilibrium Q1, both axis

Now assume that the beverage backing/shipping industry develops new technology to better transport/produce soda which Pepsi incorporates. At the same time price of pizza (a complementary good to Pepsi) increases.

b) In sentences, describe what will happen to market supply and market demand for Pepsi. In the graph above, denote these changes if any with D2 for Demand curve two, S2 for Supply curve two, P2 for price equilibrium 2, E2 for equilibrium quantity, and Q2 for quantity equilibrium. (8 points)

Answer 1

(a) In following graph, equilibrium is at point E1 where D1 intersects S1 with price P1 and quantity Q1.

(b) New technology will lower production cost, increasing supply, which will shift S1 rightward to S2, decreasing price and increasing quantity. At the same time, higher price of a complement good will decrease the demand for Pepsi, shifting its demand curve leftward from D1 to D2, decreasing price and decreasing quantity. The net effect is a definite decrease in price, but quantity may rise, fall or remain the same on basis of whether the rightward shift in supply is higher than, lower than or equal in magnitude to the leftward shift in demand. In above graph, D2 and S2 intersect at point E2 with lower price P2. In graph, leftward shift in demand equals rightward shift in supply, so quantity is unchanged at Q1.