Question

Consider the supply and demand curves for several markets – mineral resources, wheat, gasoline, and steel. Show how the following impacts on each of these markets would shift the supply curve, the demand curve, or both. How will the market equilibrium price and quantity change from the original equilibrium? What cause the changes? Explain in words and graphically.

a. As mineral resources are depleted, it becomes costlier to extract mineral deposits.

b. Due to floods in the Midwest, half of the wheat crop in the U.S. is destroyed. At the same time, the price of oats (a substitute for wheat) decreases due to a sharp rise in the number of farmers growing oats in response to consumer demand for health food.

c. Due to oil shortage, the federal government has decided to ration gasoline sales in the U.S. to half of current sales.

d. Steelworkers’ union has accepted a wage decrease to help steel companies through hard times.

Answer 1

In each graph, price (P) and quantity (Q) are depicted along vertical and horizontal axes respectively. D0 and S0 are initial demand and supply curves, intersecting at point A. Initial equilibrium price is P0 and quantity is Q0.

(a)

Higher extraction cost will increase production cost, so firms will reduce output. Supply curve shifts to left, increasing price and decreasing quantity. In following graph, S0 will shift leftward to S1, intersecting D0 at point B with higher price P1 and lower quantity Q1.

(b)

Lower price of substitute will decrease the demand for wheat. Demand curve will shift to left, decreasing price and decreasing quantity. Crop destruction will decrease market supply. The supply curve will shift to left, increasing price and decreasing quantity. The net effect is a definite decrease in quantity. But price may increase, decrease or remain unchanged as shown in following three possibilities.

(1) Demand shifts more than supply: Price falls

In following graph, D0 shifts left to D1 and S0 shifts left to S1, intersecting at point B with lower quantity Q1. Since (D0 - D1) > (S0 - S1), price is lower at P2.

(2) Demand shifts less than supply: Price rises

In following graph, D0 shifts left to D1 and S0 shifts left to S1, intersecting at point B with lower quantity Q1. Since (D0 - D1) < (S0 - S1), price is higher at P2.

(3) Demand shifts same as supply: Price unchanged

In following graph, D0 shifts left to D1 and S0 shifts left to S1, intersecting at point B with lower quantity Q1. Since (D0 - D1) = (S0 - S1), price is same at P1.

(c)

Rationed sales will decrease market supply. The supply curve shifts to left, increasing price and decreasing quantity. In following graph, S0 will shift leftward to S1, intersecting D0 at point B with higher price P1 and lower quantity Q1.

(d)

Lower wage rate will decrease production cost, causing producers to raise supply. Supply curve shifts to right, decreasing price and increasing quantity. In following graph, S0 will shift rightward to S1, intersecting D0 at point B with lower price P1 and higher quantity Q1.