Question

PROBLEM:

With the aid of supply and demand diagrams (you need an explicit diagram for each case), show and explain how and why we would expect prices and quantities to change in the market for Compact Discs (CDs) in each of the following situations when:

(a) Technical improvements lead to a fall in the cost of producing CDs.
(b) Technical improvements lead to a fall in the cost of producing MP3 players.
(c) Technical improvements lead to a fall in the cost of producing CD-players.
(d) Streaming music services, such as Spotify, AccuRadio, and Grooveshark, etc. become widely available
(e) Congress passes laws making streaming music services, such as Spotify, AccuRadio, and Grooveshark, etc. illegal.

Answer 1

a) Technical improvement lead to fall in cost of producing CDs will raise profit level of CDs producers which induce them to produce more of CDs and raise its aggregate supply. It will shift aggregate supply curve to its right from AS to AS1 while demand remains the same. It tends to reduce price level from P to P1 and raise output from Y to Y1.

b) Fall in cost of producing MP3 will reduce the price of MP3 and reduce demand of CDs because consumers look for cheaper alternative available. It will shift aggregate demand curve of CD to its left from AD to AD1 which tends to reduce price from P to P1 and reduce output from Y to Y1.

c) As CD players and CDs are complements to each other. Fall in cost of producing CD-players will leave more money with consumers to spend on CDs which will raise aggregate demand. Rise in aggregate demand shift aggregate demand curve from AD to AD1 which raise price level from P to P1 and raise output level from Y to Y1.

d) Music services such as Spotify, AccuRadio etc. become widely availabl. These goods tends to reduce aggregate supply of CDs which shift aggregate supply curve to its left from AS to AS1 while aggregate demand remains the same. It will raise price from P to P1 and reduce output from Y to Y1.

e) If Spotify, AccuRadio etc. are illegal, consumers will again prefer CDs which will raise aggregate demand of CDs and shift aggregate demand curve to its right. Rise in aggregate demand shift aggregate demand curve from AD to AD1 which raise price level from P to P1 and raise output level from Y to Y1.