Question

1. Using general equilibrium analysis, and taking into account feedback effects, analyze the following

• The likely effects of increase in insurance price on the market for cheap cars which is the car for low-income people.
• The effects of increased taxes on petrol on using air tickets for travelling to holiday destinations.

Answer 1

General equilibrium theory attempts to explain the behavior of supply, demand, and prices in a whole economy with several or many interacting markets, by seeking to prove that the interaction of demand and supply will result in an overall general equilibrium.

The effect of increase in insurance price of cheap cars which poor people use will lead to decreased demand as poor people have inverse relationship of goods consumed and prices. So if prices rises, quantity consumed falls which leads to shift in demand curve from D to D1 which cause prices and quantity consumed to fall and the equilibrium reached to its new level at point B from point A.

The effect of increased taxes on petrol on using air ticket reduces the supply by a firms as it raises the cost of operating the airline which shifts the supply curve from S to S1 which shifts the prices upwards from P to P1 and lowers the quantity consumed from Q to Q1 and gives us a new equilibrium which was initially at point A.