Question

Construct a supply and demand diagram representing the entire market for Semillon wine. Your diagram will not contain data or numbers, but will show how supply and demand interact to generate prices and quantities. Call this initial equilibrium price P⁰ and the initial equilibrium quantity Q⁰. Present and explain (including all assumptions) the following changes on your diagram (that is, just one diagram showing all of i, ii and iii below) with the single end result of a new equilibrium price P³ that is higher than P⁰.

1. Wide spread drought that reduces industry grape yields.
2. An economy wide increase in income tax rates.
3. An increase in the price of beer.

Answer 1

The Supply and Demand Diagram representing the entire market for Semillon wine is drawn below:

In the diagram, SS is the initial supply curve, S^'S^' is the new supply curve, DD is the demand curve, D^'D^' is the new demand curve, P₀ is the initial equilibrium price, P₃ is the new equilibrium price, Q₀ is the initial quantity, Q₃ is the new quantity, E₀ is the initial equilibrium, E₁ is the new equilibrium.

(i) Wide spread drought that reduces industry grape yields - When there is wide spread drought, the supply of the industry grape yields reduces and so the supply curve shifts to the leftward direction from SS to S^'S^'. The equilibrium price increases from P₀ to P₃ and the demand also decreases and the demand curve shifts in a leftward direction with the increase in price. Hence, we see that the equilibrium quantity reduces from Q₀ to Q₃ and the price increases from P₀ to P₃.

(ii) An economy wide increase in income tax rates - When there is increase in income tax rates, the demand decreases because now consumers have to pay more tax and have less disposable income in their hands. So, the demand curve shifts leftward from DD to D^'D^' and with the decrease in demand the supply also reduces and hence the new equilibrium price is P₃ which is higher than the initial equilibrium price and the new equilibrium quantity is Q₃ which is lower than the initial equilibrium quantity Q₀.

(iii) An increase in the price of beer - When the supply of beer reduces more than the reduction in the demand for beer, there is increase in the price of beer. In the diagram, the supply reduces from SS to S^'S^' and the demand also reduces from DD to D^'D^' but we see that the supply reduces more than the demand, so there is an increase in the price of the beer to P₃.