Question

Consider the market for ice cream. Suppose that the price of milk (an input into ice cream) increases. Simultaneously, ice cream consumers’ incomes fall, and these consumers view ice cream as a normal good. What would you predict will happen to the equilibrium price of ice cream? To the equilibrium quantity of ice cream? Explain and draw diagrams to support your answer.

Answer 1

In the market for ice cream, the price of milk which is used as an input into ice cream, increases. This increases cost of production and so supply at each price is reduced.; Supply function shifts left.

Simultaneously, ice cream consumers’ incomes fall, and these consumers view ice cream as a normal good. This will reduce their demand for ice cream and so demand curve shifts left.

The price will fall due to demand shift and rise due to supplt shift so we cannot predict what will happen to the equilibrium price of ice cream. We assume that if size of the shift remains same price will be unchanged

However, unambiguously the equilibrium quantity of ice cream will fall because of leftward shifts of supply and demand.