Economics Quiz Paper
Quiz No. 2 Name ------------------------------
February 13, 2014
Section BBA-B ID No. ------------------------------
Question1 The demand for housing is often described as being highly cyclical and very sensitive to housing prices and interest rates. Given these characteristics, describe the effect of each of the following in terms of whether it would increase or decrease the quantity demanded or the demand for housing. Moreover, when price is expressed as a function of quantity, indicate whether the effect of each of the following is an upward or downward movement along a given demand curve or involves an outward or inward shift in the relevant demand curve for housing. Explain your answers.
A. An increase in housing prices
B. A fall in interest rates
C. A rise in interest rates
D. A severe economic recession
E. A robust economic expansion
Solution1 A. An increase in housing prices will decrease the quantity demanded and involve an upward movement along the housing demand curve. B. A fall in interest rates will increase the demand for housing and cause an outward shift of the housing demand curve. C. A rise in interest rates will decrease the demand for housing and cause an …show more content…
inward shift of the housing demand curve. D. A severe economic recession (fall in income) will decrease the demand for housing and result in an inward shift of the housing demand curve. E. A robust economic expansion (rise in income) will increase the demand for housing and result in an outward shift of the housing demand curve.
Question2 Suppose that due to more stringent environmental regulation it becomes more expensive for steel production firms to operate. Also, recent technological advances in plastics has reduced the demand for steel products. Use Supply and Demand analysis to predict how these shocks will affect equilibrium price and quantity of steel. Can we say with certainty that the market price for steel will fall? Why?
Solution 2: The increase in the cost of production of steel will shift the supply curve to the left. This effect alone on the market will influence the market price to rise while the market quantity will fall. This is shown above by a movement from the original supply curve S0 to a new supply curve such as S1. The decrease in demand will cause the demand curve to shift to the left. This effect alone on the market will influence the market price and quantity of steel to fall. Note that the supply and demand effects on price work in opposite directions. If the supply effect dominates the demand effect, the equilibrium prices will rise. This is exhibited by the decrease in demand to D1’. On this demand curve, the net effect is for prices to rise from P0 to P1’. On the other hand if the demand effect dominates, equilibrium prices will rise. This is exhibited by the decrease in demand to D1’’. On this demand curve, the net effect is for prices to fall from P0 to P1’’. As we don’t know given the current information which effect dominates, we can’t perfectly predict the change in price. The change in quantity is unambiguously decreased.
Quiz No. 2 Name ------------------------------
February 13, 2014
Section BBA-B ID No. ------------------------------
Question 1 Suppose the cable TV industry is currently unregulated. However, due to complaints from consumers that the price of cable TV is too high, the legislature is considering placing a price ceiling on cable TV below the current equilibrium price. If the government does make this price ceiling law, diagram and explain the effects with supply and demand analysis. If the cable TV company is worried about disgruntling customers, suppose that the company may introduce a different type of programming that is cheaper for the company to provide yet is equally appealing to customers. What would be the effects of this action?
Solution 1: Before implementation of the price ceiling, the equilibrium price and quantity is given by the intersection of demand and supply.
This is illustrated above as p0 and q0. A price ceiling below the initial equilibrium price will cause a shortage. That is quantity demanded (qdc) at the price ceiling (pc) exceeds quantity supplied (qsc). To avoid upsetting consumers, the company may provide a lower quality cable TV subscription. This cheaper package would increase the supply of cable TV. The supply curve will rightward. This action will move towards eliminating the cable TV shortage as the quantity supplied of the modified package
increases.
Question2 Following a price change for Diet Coke, explain how retailers use sales information to learn if Doritos snack chips represent a complement or substitute for Diet Coke.
Solution2 Following a price change, companies use sales information to distinguish complements from substitutes by noting the size and direction of effects on demand for related products. Demand curves are downward sloping. As a result, when the price of a product is decreased, sales of that product rise. At the same time, sales of substitutes fall as customers switch to the now lower-priced alternative. When the price of a product rises, sales of that product fall but sales of substitute products rise as customers switch to the substitute’s relative bargain price. There is a positive correlation between price changes and units sold when two products are substitutes. Sales of substitutes change in the same direction of the price change for substitute products. Conversely, when the price of a product is decreased, sales of that product and complements both rise. When the price of a product rises, sales of that product fall as do sales of complementary products. There is an inverse correlation between price changes and units sold when two products are complements.
Quiz No. 2 Name ------------------------------
February 13, 2014
Section BBA-A ID No. ------------------------------
1. Suppose a new discovery in computer manufacturing has just made computer production cheaper. Also, the popularity and usefulness of computers continues to grow. Use Supply and Demand analysis to predict how these shocks will affect equilibrium price and quantity of computers. Is there enough information to determine if market prices will rise or fall? Why?
Solution 1: The increase in demand due to the usefulness of computers will shift the demand curve to the right. This effect alone on the market will influence the market price and quantity to rise. This is shown above by a movement from the original demand curve D0 to a new demand curve such as D1’ or D1’’. The reduction in the cost of producing computers will result in an increase in supply (a rightward shift of the supply curve). This effect alone on the market will influence the price of computers to fall while the quantity will increase. Note that the supply and demand effects on price work in opposite directions. If the supply effect dominates the demand effect, the equilibrium prices will fall. This is exhibited by the increase in demand to only D1’. On this demand curve, the net effect is for prices to fall from P0 to P1’. On the other hand if the demand effect dominates, equilibrium prices will rise. This is exhibited by the increase in demand to D1’’. On this demand curve, the net effect is for prices to rise from P0 to P1’’. As we don’t know given the current information which effect dominates, we can’t perfectly predict the change in price. The change in quantity is unambiguously increased.
2. Use supply and demand curves to illustrate how each of the following events would affect the price of butter and the quantity of butter bought and sold:
a. An increase in the price of margarine.
b. An increase in the price of milk.
c. A decrease in average income levels.
a. Most people consider butter and margarine to be substitute goods. An increase in the price of margarine will cause people to increase their consumption of butter, thereby shifting the demand curve for butter out from D1 to D2 in Figure 2.2.a. This shift in demand will cause the equilibrium price to rise from P1 to P2 and the equilibrium quantity to increase from Q1 to Q2.
b. Milk is the main ingredient in butter. An increase in the price of milk will increase the cost of producing butter. The supply curve for butter will shift from S1 to S2 in Figure 2.2.b, resulting in a higher equilibrium price, P2, covering the higher production costs, and a lower equilibrium quantity, Q2.
c. Assume that butter is a normal good. A decrease in the average income level will cause the demand curve for butter to shift from D1 to D2. This will result in a decline in the equilibrium price from P1 to P2, and a decline in the equilibrium quantity from Q1 to Q2.
Quiz No. 2 Name ------------------------------
February 13, 2014
Section BBA-A ID No. ------------------------------
1. Historically, investors have considered gold commodities to be a good investment to preserve wealth in times of inflation. If investors are no longer worried about inflation and gold demand decreases, what do you expect will happen to gold prices? How would your answer change if you learn that a recent gold mine discovery will increase the supply of gold?
Solution: The decrease in gold demand due to reduced fears of inflation will shift the demand curve to the left. This is indicated above by a movement from D0 to D1. The effect on gold prices is negative. If new gold discoveries increase the supply of gold, the supply curve will shift to the right. This effect will also exert downward pressure on gold prices. This effect is diagrammed above as a movement from S0 to S1. Since both effects cause gold prices to become lower, we can say unambiguously that gold prices will decline.
2. The city council of a small college town decides to regulate rents in order to reduce student living expenses. Suppose the average annual market-clearing rent for a two-bedroom apartment had been $700 per month, and rents are expected to increase to $900 within a year. The city council limits rents to their current $700 per month level.
a. Draw a supply and demand graph to illustrate what will happen to the rental price of an apartment after the imposition of rent controls.
b. Do you think this policy will benefit all students? Why or why not.
Solution
a. The rental price will stay at the old equilibrium level of $700 per month. The expected increase to $900 per month may have been caused by an increase in demand. Given this is true, the price of $700 will be below the new equilibrium and there will be a shortage of apartments.
b. It will benefit those students who get an apartment, though these students may also find that the costs of searching for an apartment are higher given the shortage of apartments. Those students who do not get an apartment may face higher costs as a result of having to live outside of the college town. Their rent may be higher and the transportation costs will be higher.
Quiz No. Name ------------------------------
February 14, 2014
Section BBA-C ID No. ------------------------------
1. The city council of a small college town decides to regulate rents in order to reduce student living expenses. Suppose the average annual market-clearing rent for a two-bedroom apartment had been $700 per month, and rents are expected to increase to $900 within a year. The city council limits rents to their current $700 per month level.
a. Draw a supply and demand graph to illustrate what will happen to the rental price of an apartment after the imposition of rent controls.
b. Do you think this policy will benefit all students? Why or why not.
Solution
a. The rental price will stay at the old equilibrium level of $700 per month. The expected increase to $900 per month may have been caused by an increase in demand. Given this is true, the price of $700 will be below the new equilibrium and there will be a shortage of apartments.
b. It will benefit those students who get an apartment, though these students may also find that the costs of searching for an apartment are higher given the shortage of apartments. Those students who do not get an apartment may face higher costs as a result of having to live outside of the college town. Their rent may be higher and the transportation costs will be higher.
2. Use a diagram to illustrate how each of the following events affects the equilibrium price and quantity of pizza.
a. The price of mozzarella cheese rises.
b. The health hazards of hamburgers are widely publicized.
c. The price of tomato sauce falls.
d. The incomes of consumers rise and pizza is an inferior good.
e. Consumers expect the price of pizza to fall next week.
f.
a. Mozzarella is an input in the production of pizza. Since the cost of an input has risen, pizza producers will reduce the quantity supplied at any given price, a leftward shift of the supply curve from S1 to S2. As a result, the equilibrium price of pizza will rise and the equilibrium quantity will fall as the equilibrium changes from E1 to E2.
b. Consumers will substitute pizza in place of hamburgers, resulting in an increased demand for pizza at any given price. This generates a rightward shift of the demand curve from D1 to D2, leading to a rise in the equilibrium price and quantity as the equilibrium changes from E1 to E2.
c. Tomato sauce is an input in the production of pizza. Since the cost of an input has fallen, pizza producers will increase the quantity supplied at any given price, a rightward shift of the supply curve from S1 to S2. As a result, the equilibrium price of pizza will fall and the equilibrium quantity will rise as the equilibrium changes from E1 to E2. d. The demand for an inferior good decreases when the incomes of consumers rise. So a rise in consumer incomes produces a leftward shift of the demand curve from D1 to D2, resulting in a lower equilibrium price and quantity as the equilibrium changes from E1 to E2.
e. Consumers will delay their purchases of pizza today in anticipation of consuming more pizza next week. As a result, the demand curve shifts leftward from D1 to D2, resulting in a lower equilibrium price and quantity as the equilibrium changes from E1 to E2.
Quiz No. Name ------------------------------
February 14, 2014
Section BBA-C ID No. ------------------------------
1. Question: A survey indicated that chocolate is Americans’ favorite ice cream flavor. For each of the following, indicate the possible effects on demand, supply, or both as well as equilibrium price and quantity of chocolate ice cream.
a. A severe drought in the Midwest causes dairy farmers to reduce the number of milk-producing cattle in their herds by a third. These dairy farmers supply cream that is used to manufacture chocolate ice cream.
b. A new report by the American Medical Association reveals that chocolate does, in fact, have significant health benefits.
c. The discovery of cheaper synthetic vanilla flavoring lowers the price of vanilla ice cream.
New technology for mixing and freezing ice cream lowers manufacturers’ costs of producing chocolate ice cream. Solution:
a. By reducing their herds, dairy farmers reduce the supply of cream, a leftward shift of the supply curve for cream. As a result, the market price of cream rises, raising the cost of producing a unit of chocolate ice cream. This results in a leftward shift of the supply curve for chocolate ice cream as ice-cream producers reduce the quantity of chocolate ice cream supplied at any given price. Ultimately, this leads to a rise in the equilibrium price and a fall in the equilibrium quantity.
b. Consumers will now demand more chocolate ice cream at any given price, represented by a rightward shift of the demand curve. As a result, both equilibrium price and quantity rise.
c. The price of a substitute (vanilla ice cream) has fallen, leading consumers to substitute it for chocolate ice cream. The demand for chocolate ice cream decreases, represented by a leftward shift of the demand curve. Both equilibrium price and quantity fall.
d. Because the cost of producing ice cream falls, manufacturers are willing to supply more units of chocolate ice cream at any given price. This is represented by a rightward shift of the supply curve and results in a fall in the equilibrium price and a rise in the equilibrium quantity.
2. After several years of decline, the market for handmade acoustic guitars is making a comeback. These guitars are usually made in small workshops employing relatively few highly skilled luthiers. Assess the impact on the equilibrium price and quantity of handmade acoustic guitars as a result of each of the following events. In your answers indicate which curve(s) shift(s) and in which direction.
a. Environmentalists succeed in having the use of Brazilian rosewood banned in the United States, forcing luthiers to seek out alternative, more costly woods.
b. A foreign producer reengineers the guitar-making process and floods the market with identical guitars.
c. Music featuring handmade acoustic guitars makes a comeback as audiences tire of heavy metal and grunge music.
d. The country goes into a deep recession and the income of the average American falls sharply.
e.
Solution:
a. The cost of producing handmade acoustic guitars rises as more costly woods are used to construct them. This reduces supply, as luthiers offer fewer guitars at any given price. This is represented by a leftward shift of the supply curve and results in a rise in the equilibrium price and a fall in the equilibrium quantity.
b. This represents a rightward shift of the supply curve, resulting in a fall in the equilibrium price and a rise in the equilibrium quantity.
c. As more people demand music played on acoustic guitars, the demand for these guitars by musicians increases as well. (Acoustic guitars are an input into the production of this music.) This represents a rightward shift of the demand curve, leading to a higher equilibrium price and quantity.
d. If average American income falls sharply, then the demand for handmade acoustic guitars will decrease sharply as well because they are a normal good. This is represented by a leftward shift of the demand curve, leading to a lower equilibrium price and quantity.
February 13, 2014
Section BBA-B ID No. ------------------------------
Question1 The demand for housing is often described as being highly cyclical and very sensitive to housing prices and interest rates. Given these characteristics, describe the effect of each of the following in terms of whether it would increase or decrease the quantity demanded or the demand for housing. Moreover, when price is expressed as a function of quantity, indicate whether the effect of each of the following is an upward or downward movement along a given demand curve or involves an outward or inward shift in the relevant demand curve for housing. Explain your answers.
A. An increase in housing prices
B. A fall in interest rates
C. A rise in interest rates
D. A severe economic recession
E. A robust economic expansion
Solution1 A. An increase in housing prices will decrease the quantity demanded and involve an upward movement along the housing demand curve. B. A fall in interest rates will increase the demand for housing and cause an outward shift of the housing demand curve. C. A rise in interest rates will decrease the demand for housing and cause an …show more content…
inward shift of the housing demand curve. D. A severe economic recession (fall in income) will decrease the demand for housing and result in an inward shift of the housing demand curve. E. A robust economic expansion (rise in income) will increase the demand for housing and result in an outward shift of the housing demand curve.
Question2 Suppose that due to more stringent environmental regulation it becomes more expensive for steel production firms to operate. Also, recent technological advances in plastics has reduced the demand for steel products. Use Supply and Demand analysis to predict how these shocks will affect equilibrium price and quantity of steel. Can we say with certainty that the market price for steel will fall? Why?
Solution 2: The increase in the cost of production of steel will shift the supply curve to the left. This effect alone on the market will influence the market price to rise while the market quantity will fall. This is shown above by a movement from the original supply curve S0 to a new supply curve such as S1. The decrease in demand will cause the demand curve to shift to the left. This effect alone on the market will influence the market price and quantity of steel to fall. Note that the supply and demand effects on price work in opposite directions. If the supply effect dominates the demand effect, the equilibrium prices will rise. This is exhibited by the decrease in demand to D1’. On this demand curve, the net effect is for prices to rise from P0 to P1’. On the other hand if the demand effect dominates, equilibrium prices will rise. This is exhibited by the decrease in demand to D1’’. On this demand curve, the net effect is for prices to fall from P0 to P1’’. As we don’t know given the current information which effect dominates, we can’t perfectly predict the change in price. The change in quantity is unambiguously decreased.
Quiz No. 2 Name ------------------------------
February 13, 2014
Section BBA-B ID No. ------------------------------
Question 1 Suppose the cable TV industry is currently unregulated. However, due to complaints from consumers that the price of cable TV is too high, the legislature is considering placing a price ceiling on cable TV below the current equilibrium price. If the government does make this price ceiling law, diagram and explain the effects with supply and demand analysis. If the cable TV company is worried about disgruntling customers, suppose that the company may introduce a different type of programming that is cheaper for the company to provide yet is equally appealing to customers. What would be the effects of this action?
Solution 1: Before implementation of the price ceiling, the equilibrium price and quantity is given by the intersection of demand and supply.
This is illustrated above as p0 and q0. A price ceiling below the initial equilibrium price will cause a shortage. That is quantity demanded (qdc) at the price ceiling (pc) exceeds quantity supplied (qsc). To avoid upsetting consumers, the company may provide a lower quality cable TV subscription. This cheaper package would increase the supply of cable TV. The supply curve will rightward. This action will move towards eliminating the cable TV shortage as the quantity supplied of the modified package
increases.
Question2 Following a price change for Diet Coke, explain how retailers use sales information to learn if Doritos snack chips represent a complement or substitute for Diet Coke.
Solution2 Following a price change, companies use sales information to distinguish complements from substitutes by noting the size and direction of effects on demand for related products. Demand curves are downward sloping. As a result, when the price of a product is decreased, sales of that product rise. At the same time, sales of substitutes fall as customers switch to the now lower-priced alternative. When the price of a product rises, sales of that product fall but sales of substitute products rise as customers switch to the substitute’s relative bargain price. There is a positive correlation between price changes and units sold when two products are substitutes. Sales of substitutes change in the same direction of the price change for substitute products. Conversely, when the price of a product is decreased, sales of that product and complements both rise. When the price of a product rises, sales of that product fall as do sales of complementary products. There is an inverse correlation between price changes and units sold when two products are complements.
Quiz No. 2 Name ------------------------------
February 13, 2014
Section BBA-A ID No. ------------------------------
1. Suppose a new discovery in computer manufacturing has just made computer production cheaper. Also, the popularity and usefulness of computers continues to grow. Use Supply and Demand analysis to predict how these shocks will affect equilibrium price and quantity of computers. Is there enough information to determine if market prices will rise or fall? Why?
Solution 1: The increase in demand due to the usefulness of computers will shift the demand curve to the right. This effect alone on the market will influence the market price and quantity to rise. This is shown above by a movement from the original demand curve D0 to a new demand curve such as D1’ or D1’’. The reduction in the cost of producing computers will result in an increase in supply (a rightward shift of the supply curve). This effect alone on the market will influence the price of computers to fall while the quantity will increase. Note that the supply and demand effects on price work in opposite directions. If the supply effect dominates the demand effect, the equilibrium prices will fall. This is exhibited by the increase in demand to only D1’. On this demand curve, the net effect is for prices to fall from P0 to P1’. On the other hand if the demand effect dominates, equilibrium prices will rise. This is exhibited by the increase in demand to D1’’. On this demand curve, the net effect is for prices to rise from P0 to P1’’. As we don’t know given the current information which effect dominates, we can’t perfectly predict the change in price. The change in quantity is unambiguously increased.
2. Use supply and demand curves to illustrate how each of the following events would affect the price of butter and the quantity of butter bought and sold:
a. An increase in the price of margarine.
b. An increase in the price of milk.
c. A decrease in average income levels.
a. Most people consider butter and margarine to be substitute goods. An increase in the price of margarine will cause people to increase their consumption of butter, thereby shifting the demand curve for butter out from D1 to D2 in Figure 2.2.a. This shift in demand will cause the equilibrium price to rise from P1 to P2 and the equilibrium quantity to increase from Q1 to Q2.
b. Milk is the main ingredient in butter. An increase in the price of milk will increase the cost of producing butter. The supply curve for butter will shift from S1 to S2 in Figure 2.2.b, resulting in a higher equilibrium price, P2, covering the higher production costs, and a lower equilibrium quantity, Q2.
c. Assume that butter is a normal good. A decrease in the average income level will cause the demand curve for butter to shift from D1 to D2. This will result in a decline in the equilibrium price from P1 to P2, and a decline in the equilibrium quantity from Q1 to Q2.
Quiz No. 2 Name ------------------------------
February 13, 2014
Section BBA-A ID No. ------------------------------
1. Historically, investors have considered gold commodities to be a good investment to preserve wealth in times of inflation. If investors are no longer worried about inflation and gold demand decreases, what do you expect will happen to gold prices? How would your answer change if you learn that a recent gold mine discovery will increase the supply of gold?
Solution: The decrease in gold demand due to reduced fears of inflation will shift the demand curve to the left. This is indicated above by a movement from D0 to D1. The effect on gold prices is negative. If new gold discoveries increase the supply of gold, the supply curve will shift to the right. This effect will also exert downward pressure on gold prices. This effect is diagrammed above as a movement from S0 to S1. Since both effects cause gold prices to become lower, we can say unambiguously that gold prices will decline.
2. The city council of a small college town decides to regulate rents in order to reduce student living expenses. Suppose the average annual market-clearing rent for a two-bedroom apartment had been $700 per month, and rents are expected to increase to $900 within a year. The city council limits rents to their current $700 per month level.
a. Draw a supply and demand graph to illustrate what will happen to the rental price of an apartment after the imposition of rent controls.
b. Do you think this policy will benefit all students? Why or why not.
Solution
a. The rental price will stay at the old equilibrium level of $700 per month. The expected increase to $900 per month may have been caused by an increase in demand. Given this is true, the price of $700 will be below the new equilibrium and there will be a shortage of apartments.
b. It will benefit those students who get an apartment, though these students may also find that the costs of searching for an apartment are higher given the shortage of apartments. Those students who do not get an apartment may face higher costs as a result of having to live outside of the college town. Their rent may be higher and the transportation costs will be higher.
Quiz No. Name ------------------------------
February 14, 2014
Section BBA-C ID No. ------------------------------
1. The city council of a small college town decides to regulate rents in order to reduce student living expenses. Suppose the average annual market-clearing rent for a two-bedroom apartment had been $700 per month, and rents are expected to increase to $900 within a year. The city council limits rents to their current $700 per month level.
a. Draw a supply and demand graph to illustrate what will happen to the rental price of an apartment after the imposition of rent controls.
b. Do you think this policy will benefit all students? Why or why not.
Solution
a. The rental price will stay at the old equilibrium level of $700 per month. The expected increase to $900 per month may have been caused by an increase in demand. Given this is true, the price of $700 will be below the new equilibrium and there will be a shortage of apartments.
b. It will benefit those students who get an apartment, though these students may also find that the costs of searching for an apartment are higher given the shortage of apartments. Those students who do not get an apartment may face higher costs as a result of having to live outside of the college town. Their rent may be higher and the transportation costs will be higher.
2. Use a diagram to illustrate how each of the following events affects the equilibrium price and quantity of pizza.
a. The price of mozzarella cheese rises.
b. The health hazards of hamburgers are widely publicized.
c. The price of tomato sauce falls.
d. The incomes of consumers rise and pizza is an inferior good.
e. Consumers expect the price of pizza to fall next week.
f.
a. Mozzarella is an input in the production of pizza. Since the cost of an input has risen, pizza producers will reduce the quantity supplied at any given price, a leftward shift of the supply curve from S1 to S2. As a result, the equilibrium price of pizza will rise and the equilibrium quantity will fall as the equilibrium changes from E1 to E2.
b. Consumers will substitute pizza in place of hamburgers, resulting in an increased demand for pizza at any given price. This generates a rightward shift of the demand curve from D1 to D2, leading to a rise in the equilibrium price and quantity as the equilibrium changes from E1 to E2.
c. Tomato sauce is an input in the production of pizza. Since the cost of an input has fallen, pizza producers will increase the quantity supplied at any given price, a rightward shift of the supply curve from S1 to S2. As a result, the equilibrium price of pizza will fall and the equilibrium quantity will rise as the equilibrium changes from E1 to E2. d. The demand for an inferior good decreases when the incomes of consumers rise. So a rise in consumer incomes produces a leftward shift of the demand curve from D1 to D2, resulting in a lower equilibrium price and quantity as the equilibrium changes from E1 to E2.
e. Consumers will delay their purchases of pizza today in anticipation of consuming more pizza next week. As a result, the demand curve shifts leftward from D1 to D2, resulting in a lower equilibrium price and quantity as the equilibrium changes from E1 to E2.
Quiz No. Name ------------------------------
February 14, 2014
Section BBA-C ID No. ------------------------------
1. Question: A survey indicated that chocolate is Americans’ favorite ice cream flavor. For each of the following, indicate the possible effects on demand, supply, or both as well as equilibrium price and quantity of chocolate ice cream.
a. A severe drought in the Midwest causes dairy farmers to reduce the number of milk-producing cattle in their herds by a third. These dairy farmers supply cream that is used to manufacture chocolate ice cream.
b. A new report by the American Medical Association reveals that chocolate does, in fact, have significant health benefits.
c. The discovery of cheaper synthetic vanilla flavoring lowers the price of vanilla ice cream.
New technology for mixing and freezing ice cream lowers manufacturers’ costs of producing chocolate ice cream. Solution:
a. By reducing their herds, dairy farmers reduce the supply of cream, a leftward shift of the supply curve for cream. As a result, the market price of cream rises, raising the cost of producing a unit of chocolate ice cream. This results in a leftward shift of the supply curve for chocolate ice cream as ice-cream producers reduce the quantity of chocolate ice cream supplied at any given price. Ultimately, this leads to a rise in the equilibrium price and a fall in the equilibrium quantity.
b. Consumers will now demand more chocolate ice cream at any given price, represented by a rightward shift of the demand curve. As a result, both equilibrium price and quantity rise.
c. The price of a substitute (vanilla ice cream) has fallen, leading consumers to substitute it for chocolate ice cream. The demand for chocolate ice cream decreases, represented by a leftward shift of the demand curve. Both equilibrium price and quantity fall.
d. Because the cost of producing ice cream falls, manufacturers are willing to supply more units of chocolate ice cream at any given price. This is represented by a rightward shift of the supply curve and results in a fall in the equilibrium price and a rise in the equilibrium quantity.
2. After several years of decline, the market for handmade acoustic guitars is making a comeback. These guitars are usually made in small workshops employing relatively few highly skilled luthiers. Assess the impact on the equilibrium price and quantity of handmade acoustic guitars as a result of each of the following events. In your answers indicate which curve(s) shift(s) and in which direction.
a. Environmentalists succeed in having the use of Brazilian rosewood banned in the United States, forcing luthiers to seek out alternative, more costly woods.
b. A foreign producer reengineers the guitar-making process and floods the market with identical guitars.
c. Music featuring handmade acoustic guitars makes a comeback as audiences tire of heavy metal and grunge music.
d. The country goes into a deep recession and the income of the average American falls sharply.
e.
Solution:
a. The cost of producing handmade acoustic guitars rises as more costly woods are used to construct them. This reduces supply, as luthiers offer fewer guitars at any given price. This is represented by a leftward shift of the supply curve and results in a rise in the equilibrium price and a fall in the equilibrium quantity.
b. This represents a rightward shift of the supply curve, resulting in a fall in the equilibrium price and a rise in the equilibrium quantity.
c. As more people demand music played on acoustic guitars, the demand for these guitars by musicians increases as well. (Acoustic guitars are an input into the production of this music.) This represents a rightward shift of the demand curve, leading to a higher equilibrium price and quantity.
d. If average American income falls sharply, then the demand for handmade acoustic guitars will decrease sharply as well because they are a normal good. This is represented by a leftward shift of the demand curve, leading to a lower equilibrium price and quantity.