Question

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

a. Assume pasta and red wine are Complements. Furthermore, suppose the price of red wine increases. Illustrate the effect of the price change on the Demand Curve for Pasta.

b. Additionally, there is a (positive) technological improvement in pasta production. Illustrate the effect of the new technology on the Supply Curve for Pasta.

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)

Higher price of complement decreases demand for pasta, shifting demand curve leftward, decreasing both price and quantity.

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

(b)

Technological advancement decreases production cost, increasing market supply. This will shift supply curve rightward, decreasing price and increasing quantity.

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

(c)

When both take place at the same time:

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

In part (b), demand curve shifts leftward, decreasing both price and quantity.

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

(A) Leftward shift in demand is greater than the rightward shift in supply: Quantity decreases

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

(B) Leftward shift in demand is lower than the rightward shift in supply: Quantity increases

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

(C) Leftward shift in demand is same as the leftward shift in supply: Quantity remains the same

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