Question

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

In all graphs, D1 and S1 are initial demand and supply curves intersecting at point A with initial equilibrium price P1 and quantity Q1.

(a)

Lower cost of production will increase supply of CD, shifting supply curve rightward, decreasing price and increasing quantity.

In following graph, S1 shifts right to S2, intersecting D1 at point B with lower price P2 and higher quantity Q2.

(b)

Lower cost of MP3 players will decrease the price of MP3 players, which is a complement to CDs (assuming MP3 players can also play CDs). Lower price of a complement good will increase demand for CDs, shifting demand curve rightward, increasing both price and quantity.

In following graph, D1 shifts right to D2, intersecting S1 at point B with higher price P2 and higher quantity Q2.

(c)

Lower cost of producing CD players will decrease the price of CD players, which is a complement to CDs. Lower price of a complement good will increase demand for CDs, shifting demand curve rightward, increasing both price and quantity.

In following graph, D1 shifts right to D2, intersecting S1 at point B with higher price P2 and higher quantity Q2.

(d)

Streaming services being substitute to CDs, higher availability of streaming services will decrease demand for CDs, shifting demand curve leftward, decreasing both price and quantity.

In following graph, D1 shifts left to D2, intersecting S1 at point B with lower price P2 and lower quantity Q2.

(e)

Streaming services being substitute to CDs, lower (legal) availability of streaming services will increase demand for CDs, shifting demand curve rightward, increasing both price and quantity.

In following graph, D1 shifts right to D2, intersecting S1 at point B with higher price P2 and higher quantity Q2.