Question

1. Suppose that good X and good Y are substitutes:

1.1) What will happen to the equilibrium prices and quantities for good X and good Y if input prices for good X increase? Explain by drawing demand and supply curves.

1.2) What will happen to the equilibrium prices and quantities for good X and good Y if there is improvement in production technology for good Y? Explain by drawing demand and supply curves.

Answer 1

In the above mentioned figures ;

Figure-1. represents excess supply of good X .

Figure -2. Represents excess demand of good y.

S - supply curve

D - demand curve

E - Equilibrium point of demand and supply

P0 - Is the equilibrium price

P1 - Change in price.

Q1- change in quantity

Q0- equilibrium quantity

If input cost of good X is increased then price of good also increases from P0 to P1 (Fig -1) as a result the demand of good x will decrease from Q0 to Q1.(Fig-1) . Decrease in demand will lead to the supply become excess. As X and Y are substitute goods, the decreased demand of good x will result in increase in demand of good Y from Q0 to Q1. and as the price of good X is increased as mentioned in (fig-1) therefore the price of y is decreased from equilibrium price (p0) to p1 (Fig-2)   Also the sudden increase in demand of good Y results in excess demand.

If technology for production of good Y is improved then then the cost of production of good Y is decreased. so the price of good Y also reduced (P0 – P1) in (fig-2). due to the fall in price of good Y the people start buying more thereby increasing the demand of Y from Q0 to Q1 in (fig- 2) resulting an excess demand .As X & Y are substitute goods, increase in   demand of Y will lead to decrease in demand of X from Q0 to Q1 ( fig 1).