Supply Equilibrium Conditions

Questions: 1. Explain using a diagram what would happen in the market for car tires if at the same time there was an increase in the prices of rubber used in the production of tires and a decrease in the price for cars. Explain the effects on price and quantity. 2. In a perfectly competitive market for apples explain would happen in the shortrun to the market and to individual producers if the price for pears went up. Demonstrate your answer using a diagram. With reference to the same diagram show what would happen to the market and individual producers in the long-run. Answers: 1. If at the same time there is an increase in the prices of rubber and decrease in the prices of car, then supply of cars will decrease due to increase in production cost and demand of cars will increase due to fall in the price. It will make the demand curve shift to the right and supply curve shift to the left. The ultimate effect on equilibrium output and price depends on the rate at which the changes take place. If demand shifts more than the supply, then at new equilibrium, price and quantity both increases. If supply shifts more than the demand, then at new equilibrium, price increases, quantity demand decreases. If both the curve shifts at the same rate then only price increases and quantity demanded and supplied remains unchanged (Salter and Luther 2016). Figure 1: Demand Supply Equilibrium conditions Source: Author In figure 1, the first situation of the change is shown, i.e. shift in demand is greater than the shift in supply that leads to the increase in price and decrease in quantity demanded and supplied at the new equilibrium point B (Salter and Luther 2016). 2. In a perfect competitive market for apples, if the price of pears increases, then people will shift their demand to apples and the demand for apples will increase at the given market situation. It will create excess demand and will lead to increase in the price. Firm will earn supernormal profit due to rise in price in short run (Salter and Luther 2016). Figure 2: Short run equilibrium of Perfect Competition Market Source: Author Figure 1 shows the original equilibrium price and output at P1 and Q1 for the industry and q1 output for the firm. When the demand for apple increases, market equilibrium has shifted to P2 and Q2 and firms equilibrium shifts to q2 where it earns supernormal profit in short run, shown by the shade area in the graph (Salter and Luther 2016). In the long-run, the excess profit of the firm vanishes and firm again earns normal profit where total revenue is equal to total cost. Due to excess profit in the short run, new firms enter the market, industry supply increase and price falls, till the excess profit get exhausted. Hence, in the long run, market equilibrium comes back to P1 and Q1 (Case 2014). References Argy, V., 2013. International macroeconomics: theory and policy. Routledge. Burda, M. and Wyplosz, C., 2012. Macroeconomics: a European text. Oxford university press. Case, K.E., Fair, R.C. and Oster, S., 2014. Principles of Microeconomics. Pearson Higher Ed. Frydman, R. and Phelps, E.S., 2013. Rethinking expectations: The way forward for macroeconomics. Princeton University Press. Mankiw, N.G.R.E.G.O.R.Y., 2014. Principles of macroeconomics. Cengage Learning. Salter, A.W. and Luther, W.J., 2016. The Optimal Austrian Business Cycle Theory. In Studies in Austrian Macroeconomics (pp. 45-60). Emerald Group Publishing Limited.