Question

Consider the markets for (a) steel and (b) automobiles. Both markets are assumed to be perfectly competitive. Answer the following questions.

a. Suppose that the price falls below the market-clearing price in the steel market, but it rises above the market-clearing price in the automobile market. Indicate the impact of these events on market prices and quantities in the steel and automobile markets. Draw a separate graph for each market. Explain.

b. Suppose the government eases regulations in steel industry, thereby lowering the cost of producing steel. How would the easing of regulations affect the market for steel and the market for automobiles, respectively? Draw a supply-and-demand diagram for each market. Illustrate any shifts in supply and/or demand. Indicate what happens to the equilibrium price and quantity in each market. Explain.

c. Suppose that automobiles are normal goods, and that an economic expansion raises incomes. How would increase in incomes affect the market prices and quantities in the automobile and steel markets, respectively? Draw separate graphs for each market. Illustrate any shifts in supply and/or demand. Indicate what happens to the equilibrium price and quantity in each market. Explain.

d. Suppose in response to positive news about trade negotiations between the US and the rest of the world, participants in the steel market expect the price of steel to fall in the future. How does the expectation of lower prices in the future affect the market for steel and the market for automobiles today? Use supply-and-diagrams to illustrate the impact of the market prices and quantities in each market. Illustrate any shifts in supply and/or demand. Indicate what happens to the equilibrium price and quantity in each market. Explain.

Answer 1

a. Since there is a fall in price, there is a movement along the curve. In the steel market as price falls below the market clearing price (Pe) these leads to increase in quantity demanded due to fall in price and a decrease in quantity supplied due to fall in price. Alternatively in the automobile market as price rises above equilibrium, quantity demanded decreases below the market clearing quantity while quantity supplied rises above the market clearing quantity- Qe. Hence if market do not adjust there will be shortage in steel industry (Qd>Qs) and surplus in automobile industry (Qs>Qd).

b. As cost of production of steel decreases, then more can be supplied at any given price. Hence supply will shift rightwards from S1 to S2. These decreases equilibrium price from Pe to Pn while equilibrium quantity increases from Qe to Qn. The quantity demanded increases along the demand curve from e to en point. As steel is a input in the automobile industry, a decrease in price of steel, decreases cost of production of automobiles and hence supply for automobile increases from S1 to S2 and so equilibrium price decreases while quantity increases as more is being supplied and demanded.

c. An income rises, people can buy more at any given price. An increase in income decreases real price of automobiles hence demand increases from D1 to D2 which causes an increase in equilibrium price and quantity. Due to this increase in demand for automobiles, producers increase their supply along the supply curve from e to en. As they increase their supply, they would require more inputs i.e steel. Hence produers of automobile demand more steel and hence the demand for steel increases in the steel market. This leads to an increase in equilibrium price and quantity in the steel market.

d. A fall in expectation of future price of steel induces people to hold back their current demand, This decreases demand and shifts demand curve to the left from D1 to D2 which leads to fall in equilibrium price and quantity. As equilibrium price of steel falls, it implies that the input cost of automobile industry has decreased. This shifts the supply curve to the right from S1 to S2 which leads to decrease in equilbrium price of automobile while an increase in equilibrium quantity of automobile.