Question

a) Using diagrams and supply and demand concept, carefully explain the impact of each of the following on equilibrium price and quantity of certain products. i) Simultaneous decrease in price of raw material and decrease in income for a normal good (other things being equal). ii) Simultaneous increase in business taxes and an increase in consumer income for a normal good (other things being equal).

Answer 1

As the price of raw material decreases, the supply of the good will increase and the supply curve will shift rightward from S1 to S2. Now as there is a decline in income for a normal good, the demand curve shifts leftward from D1 to D2.

Now when the rightward shift of the supply curve is higher than the leftward shift of the demand curve, then as the economy moves from point A to point B, then the equilibrium price falls from P1 to P2 and the equilibrium quantity increases from Q1 to Q2 (panel A).

When the leftward shift of the demand curve is higher than the rightward shift of the supply curve, then as the economy moves from point A to point B, then the equilibrium price falls from P1 to P2 and the equilibrium quantity decreases from Q1 to Q2 (panel B).

When the leftward shift of the demand curve is equal to the rightward shift of the supply curve, then as the economy moves from point A to point B, then the equilibrium price falls from P1 to P2 and the equilibrium quantity remains unchanged at  Q1 (panel C).

ii. As there is an increase in business taxes, the supply of the good will fall and the supply curve will shift leftward from S1 to S2. Also as there is an increase in consumer income for a normal good, the demand curve shifts rightward from D1 to D2.

Now, When the rightward shift of the demand curve is lower than the leftward shift of the supply curve, then as the economy moves from point A to point B, the equilibrium price increases from P1 to P2 and the equilibrium quantity decreases from Q1 to Q2(Panel A)

When the rightward shift of the demand curve is higher than the leftward shift of the supply curve, then as the economy moves from point A to point B, the equilibrium price increases from P1 to P2 and the equilibrium quantity increases from Q1 to Q2(Panel B)

When the rightward shift of the demand curve is equal to the leftward shift of the supply curve, then as the economy moves from point A to point B, the equilibrium price increases from P1 to P2 and the equilibrium quantity remains unchanged at  Q1 (Panel C).