Question

According to the New York Times (11/18/06) the number of car producers in China is increasing rapidly. The newspaper reports that “China has more car brands now than the United States.” But while car sales have climbed 38% in the first three quarters of the year, automakers have increased their output even faster, causing fierce competition and a slow erosion of prices.” At the same time, Chinese consumer incomes have risen. Assume that cars are a normal good. Use a diagram of the supply and demand curves from cars in China to show what is happening. Explain verbally, too. Label and describe shifts and directions of Q and P carefully.

Explain in 2 Paragraphs mininum. include diagram.

Answer 1

Let us consider an initial situation. The demand and supply of cars in China is given by D₁ and S₁ respectively. The equilibrium prices and quantity is given by P₁ and Q₁ respectively.

Now consider the scenario where while car sales have climbed 38% in the first three quarters of the year. To respond to this, automakers have increased their output even faster, causing fierce competition and a slow erosion of prices. This implies that now car makers are willing to manufacture more number of cars at the same prices because of excess ouput. This increase is represented by a right ward shift in the supply curve, causing the supply curve to move to S₂ from S₁. However, there has also been a rise in consumer household incomes in China. Assuming that cars are a normal good, an increase in income will lead to an increase in the consumption of cars. This means that the consumers would consume more amount of cars at the same prices. This is represented by a right ward shift in demand curve from D₁ to D₂.

The final equilibrium in the car market depends on the magnitude of shifts in the demand and supply curves. If the magnitude of the shift is higher for the supply curve, it would lead to lower prices of cars and higher quantity. However, if the magnitude of the shift of demand curve is higher than that of supply curve, it will lead to higher price levels and higher equilibrium quantity of cars. In this scenario, it looks like the magnitude of shift is higher for the supply curve than that of the demand curve.

As we can see from the above diagram, both the demand and supply curves have shifted rightward to D₂ and S₂ respectively. However, as the magnitude of the shift was higher for supply curve, the final price ( P₂ ) is lower than P₁ and the final equilibrium quantity Q₂ is higher than Q₁.

If however, the magnitude of shift was higher for the demand curve

As we can see from the above diagram, both the demand and supply curves have shifted rightward to D₂ and S₂ respectively. However, as the magnitude of the shift was higher for demand curve, the final price ( P₂ ) is higher than P₁ and the final equilibrium quantity Q₂ is higher than Q₁.