Question

(a) Wheat and oats, which are both used to make cereal (hence they are substitutes), are grown in the Prairies. What would happen to supply and demand of oats if the price of wheat were to rise? Explain your solution. (2+2)

(b) Present a properly labelled graphical presentation of the above situation. You may support the graphical representation with the explanation of the graph to clearly explain the scenario. (3+3)

Answer 1

(a) Wheat and oats are substitutes which means that one either uses wheat or oats and not both together. So if one is demanded more and other will be demanded less. As the situation presents to us - there is rise in the price of wheat. This price rise will decrease quantity demanded of wheat (based on law of demand). As less quantity of wheat is demanded it means some other alternative must be used - which is oats here. Hence demand for oats will rise. So more oats will be demanded at the initial oats price and so due to the demand shock, demand curve will shift to the right. This will raise prices which is turn will induce suppliers to supply more oats along the upward rising supply curve.

(b) The image represents the market for oats. As the substitute of oats - wheat becomes expensive people shift to oats. Initially demand and supply conditions are D1 and S1 at 1 equilibrium corresponding to P1, Q1 price and quantity. The positive demand shock shift demand rightwards to D2. This raises prices to P2. The quantity supplied rises along the supply curve and equilibrium quantity rises to Q2 at 2 equilibrium.