Question

Please draw a supply and demand diagram for the “Market for Tom Jones Records” and answer the following questions (Label all axes and curves).

a. Assume Tom Jones records and wine are complements. Additionally, the price of wine decreases. Illustrate the effect of the price change on the Demand Curve for Tom Jones records.

b. Furthermore, the government enacts a Tom Jones tax (on the supply side). In other words, suppliers of Tom Jones records must now pay a tax per every unit sold. Illustrate the effect of the tax on the Supply Curve for Tom Jones records.

c. How do the changes in demand and supply affect equilibrium price P* and equilibrium quantity Q*? That is, do price and quantity rise, fall, or remain unchanged, or are the answers indeterminate because they depend on the magnitudes of the shifts?

Answer 1

In each graph, price (P) and quantity (Q) are shown at vertical and horizontal axes. D0 and S0 are initial demand and supply curves of coffee, intersecting at point A with equilibrium price P0 and quantity Q0.

(a)

Lower price of complement increases demand for records, shifting demand curve rightward, increasing both price and quantity.

In following graph, D0 shifts right to D1, intersecting S0 at point B with higher price P1 and higher quantity Q1.

(b)

A tax incraeses effective cost, which will decrease supply, shifting supply curve leftward, increasing price and decreasing quantity.

In following graph, S0 shifts left to S1, intersecting D0 at point B with higher price P1 and lower quantity Q1.

(c)

When both take place at the same time:

In part (a), demand curve shifts rightward, increasing price and increasing quantity.

In part (b), supply curve shifts leftward, increasing price and decreasing quantity.

The net effect is a definite increase in price. But quantity may increase, decrease or remain unchanged depending on relative shift in the curves, and 3 possible situations arise:

(I) Rightward shift in demand is more than the leftward shift in supply: Quantity increases

In following graph, D0 shifts right to D1 and S0 shifts left to S1, intersecting at point B with higher price P1 and higher quantity Q1.

(II) Rightward shift in demand is less than the leftward shift in supply: Quantity decreases

In following graph, D0 shifts right to D1 and S0 shifts left to S1, intersecting at point B with higher price P1 and lower quantity Q1.

(C) Rightward shift in demand is equal to the leftward shift in supply: Quantity stay the same

In following graph, D0 shifts right to D1 and S0 shifts left to S1, intersecting at point B with higher price P1 and same quantity Q0.