Question

3. Typically, some factor, other than the product’s own price, is either a determinant of the quantity demanded, or the quantity supplied. When it comes to the market for ice cream, however, frozen yogurt is an exception. As you saw, frozen yogurt is both a substitute in consumption and a substitute in production (because firms that make ice cream usually also produce frozen yogurt). We examined how a change in the price of frozen yogurt affects the demand side and the supply side of the market for ice cream independently. Let us now focus on the entire picture. Starting from the equilibrium position in the market for ice cream, suppose that the price per unit of frozen yogurt rose. In a SINGLE diagram,

a) illustrate graphically what will happen to the market demand curve and the market supply curve for ice cream and show the ultimate equilibrium point, equilibrium price per unit of ice cream and equilibrium quantity of ice cream after this change.
b) How does the ultimate equilibrium price of ice cream compare with the original equilibrium price? How does the ultimate equilibrium quantity of ice cream compare with the original equilibrium quantity? Provide a very short explanation for your answers. If you think that, in addition to the case depicted in your diagram in part a), there may be other possibilities, illustrate each of them graphically next to the first diagram.

Answer 1

There are many other factors that determine the quantity demanded or supplied, but assuming all the other factors except price 'P' to remain constant, the equilibrium in the market for ice cream is attained at point E, where the supply curve intersects with the demand curve-

The equilibrium quantity of ice cream is Q* and the equilibrium price is P*.

a) Now it is given that frozen yogurt is substitute for both the production and consumption of icecream. That is, if the price per unit of yogurt increases, consumption (demand) and production (supply) of icecream will increase and shift the demand and supply curve for icecream to the left. The quantity demanded of icecream increases. To illustrate this, I present the next figure-

Now, due to the increase in the price per unit of yogurt, both the demand and supply curves shift to the right to D' and S'. The two curves now intersect at E', and the new equilibrium quantity is Q*', which is greater than the original equilibrium quantity Q. The new equilibrium price, however, can increase or decrease or remain the same (we will discuss that in part 'b' of your question).

b) the ultimate equilibrium price, according to my above illustration in part 'a', has definitely risen as compared to the original price of icecream.

The ultimate equilibrium quantity of ice cream (Q*') is definitely larger or greater than the original equilibrium quantity(Q*) of icecream.

In addition to the case depicted in part 'a' of the answer, there are two possible other cases of price change. I will discuss the two other cases now. It is to be noted that in these two other cases, the new equilibrium quantity remains greater than the original equilibrium quantity level. Considering the illustration in part 'a' as case 1( where demand curve shift further to the left than the shift in supply curve, i.e, demand curve shift more in comparison to supply curve), we now discuss case 2 and case 3-

Case 2- supply and demand curves shift to the left by same proportion. As can be seen from the figure, ultimate equilibrium quantity increases to Q*' and price remains constant at P* -

Case 3- supply curve and demand curve shift to the left,but supply shifts more in comparison to demand. Then as can be seen from the figure, ultimate equilibrium quantity Q*' increases, but ultimate equilibrium price P*' is lower than the original equilibrium price P*.