Question

For the scenarios discussed below, use supply and demand curves and a graph to analyze what will happen to both price and quantity in equilibrium given the information available below. Graphs MUST be half a page each. When it is impossible to pin down the direction of the effect, discuss what is more likely in your opinion and why. Make sure to differentiate between movements of curves and movements on curves. For example, you could say something like this: “the supply curve moves to the right. As a result, price decreases, and quantity supplied (and demanded) in equilibrium increases”.

1. You are the CEO of Philip Morris. The FDA announces that cigarettes are unhealthy. Analyze the market for cigarettes. What could you do to increase profitability given the news?

Answer 1

A negative consumption report will shift consumer preference away from cigarette, which will decrease demand. Demand curve shifts to left, decreasing price and decreasing quantity. This reduces total revenue, and costs remaining unchanged, lower revenue will decrease profitability. To increase profitability, I should focus at my cost structure to make it more efficient. If average cost per unit decreases, profitability will improve.

In following graph, D0 & S0 are initial demand and supply curves, intersecting at equilibrium point A with initial equilibrium price P0 and initial equilibrium quantity Q0. With lower demand, D0 shifts left to D1, intersecting S0 at point B with lower price P1 and lower quantity Q1.