Question

For each of the following scenarios, use a supply and demand diagram to illustrate the effect of the given shock on the equilibrium price and quantity in the specified competitive market. Explain whether there is a shift in the demand curve, the supply curve, or neither. (a) (5 points) An unexpected temporary heat wave hits the East Coast. Show the effect in the ice cream market in New England. (b) (5 points) The government introduces a tax on ice cream which is paid by producers. What is the effect in the ice cream market? (c) (5 points) China and Mexico are major producers of textiles. Workers in Mexico decide to go on strike. Show the effect on the market for Mexican textiles. (d) (5 points) Show the effect of the situation described in (c) on the market for Chinese textiles. (e) (5 points) Suppose the government imposes a price cap on bottled water. Show the effect in the bottled water market.

Answer 1



a. A heat wave will increase the temperature in the East Coast. This will lead to an increase in the demand for ice creams which will shift the equilibrium price to P₁ and quantity shifts to Q_1. This means that the shift in demand will lead to an increase in both price and quantity.

b. When there is tax imposed which has to be paid by producers, this increases their cost of production. This will lead to a decrease in supply as producers are discouraged. This will lead to a leftward shift in the supply curve. This means that equilibrium quantity will reduce and equilibrium price will rise as shown in the figure. The new equilibrium price is P₁ and equilibrium quantity is Q_1.

c. A strike would mean that the supply will reduce. This means that the supply curve will shift to the left. This will lead to a reduction in equilibrium quantity and increase in equilibrium price. The new equilibrium price is higher as denoted by P₁ and the equilibrium quantity is lesser as denoted by Q_1.

d. Consumers will switch to buying Chinese textiles as Mexican textiles price has increased. This will then lead to a shift in the demand curve which will lead to an increase in the equilibrium price and quantity. This is denoted in the graph as P₁ and Q_1.