Question

Using the market model, show graphically the effect on the equilibrium price and quantity of good A if the following occur (5 points each):

1. an increase in the price of substitute good B

2. an increase in income, and good A is an inferior good

3. an increase in the wage rate paid to the resource labor

4. a decrease in the sales tax applied to the good

Answer 1

1. Increase in price of substitute good B causes increase in demand of good A in the market. As demand of A increases due to change in factors other than price of commodity A, demand curve shifts rightwards.

Equilibrium price and quantity both rises.

2. Inferior goods are those goods whose income effect is negative which means increase in income decreases demand of inferior good and vice-versa. So, increase in income decreases demand of A and shifts demand curve leftwards.

Equilibrium price and quantity both falls.

3. Increase in wage rate increases cost of producing good A and as a result, supply of good A decreases in the market. This causes leftward shift of supply curve.

Equilibrium price increases while equilibrium quantity falls.

4. Decrease in sales tax increases supply of good A in the market and shift supply curve rightward.

Equilibrium price will decrease and equilibrium quantity will increase.