Question

The Market Forces of Supply and Demand (Continued from Q1)

Consider two functions:

Supply function: ? = ? + 5

Demand function: ? = 20 − 4?

a. For some reasons (e.g. wage level rises), the supply decreases. Note that it means the supply curve shifts to the left. More precisely, consider the quantity supplied decreases by 5 units for each price level. Write down a new supply function and draw a graph of the new supply curve and demand curve. [Hint: See part f in Question 1.]

b. Compare the new equilibrium quantity and price (we often call this pair of quantity and price a market outcome) to the old one in part e in question 1. Does the equilibrium price increase? Does the equilibrium quantity increase?

Answer 1

In the Initial condition

Qs=P+5

Qd=20-4P

Set Qs=Qd for equilibrium

P+5=20-4P

5P=15

P=$3 (Initial equilibrium price)

Qs=P+5=3+5=8

Qd=20-4P=20-4*3=8

So, Initial equilibrium quantity=Qd=Qs=8 units

a)

Suppose supply is decreased by 5 units at every price level. So, new supply curve is given as

Qs'=Qs-5=P+5-5=P

Qd=20-4P

Set Qs=Qd for equilibrium

P=20-4P

5P=20

P=$4 (Revised equilibrium price)

Qs'=P=4

Qd=20-4P=20-4*4=4

So, Revised equilibrium quantity=Qd=Qs'=4 units

b)

We can see that

New equilibrium price is higher than the initial equilibrium price

New equilibrium quantity is lower than the initial equilibrium price

1. Does the equilibrium price increase?

Refer earlier calculations, Yes, the equilibrium price has increased.

2. Does the equilibrium quantity increase?

Refer earlier calculations, No, the equilibrium price has decreased.