SUPPLY, DEMAND, AND MARKET EQUILIBRIUM
Practice Problems

Multiple choice questions.

1. Assume cars and gasoline are complements. When the price of gasoline goes up, which of the following will happen to the market for cars?
a. The equilibrium price of cars will increase.
b. The equilibrium quantity of cars will decrease.
c. The supply curve for cars will shift to the left.
d. The supply curve for cars will shift to the right.
e. The demand curve for cars will shift to the right.
f. None of the above.

2. Suppliers produce two goods, cheese and butter. Assume that there is no cost to switch resources from cheese production to butter production and vice versa. Suppose the demand for butter increases. What do we expect to happen to the equilibrium in the market for cheese?
a. The price will go up and the quantity will drop.
b. The price will go up and the quantity will rise.
c. The price will go down and the quantity will drop.
d. The price will go down and the quantity will rise.
e. None of the above.

3. If the government announces today that a tax increase of 50 cents per pack of cigarettes is to take place in two weeks, what would you expect to happen today to the current market for cigarettes?
a. The demand for cigarettes would increase.
b. The demand for cigarettes would decrease.
c. The price of cigarettes would increase.
d. Both a) and c) are correct.
e. Both b) and c) are correct.

4. If bread is an inferior good, then what will happen in the market for bread as the consumer income increases?
a. The quantity will increase.
b. The quantity will decrease.
c. The price will fall.
d. Both a) and c) are correct.
e. Both b) and c) are correct.


Short-answer questions.

1. If consumers expect the price of some good to rise next week, then we generally observe the price of the good rising this week. Explain this fact using a graph.


If the good is storable, and an increase in price is expected, consumers will want to buy the good today, before the price increases. As a result, the current demand for the good increases, which results in an increase in the price of the good today. See graph.
Supply and Demand diagram

2. The drought in the plain states has made grain, and therefore feed, quite expensive. Many ranchers cannot afford to feed their cattle, and have sold much of their herd for slaughter.
a. What will be the immediate effect of this event on the equilibrium price and quantity of beef? Illustrate using a supply and demand diagram.

Slaughtering the cows will result in an increase in the supply of beef to the market, which will in turn lead to a decrease in the equilibrium price of beef and an increase in the equilibrium quantity of beef. See graph.
Supply and Demand diagram Market for beef

b. Chicken and beef are substitute goods. Illustrate the effect that the slaughter of the cattle herds will have on the equilibrium price and quantity of chicken.

As the price of beef decreases, consumers will buy more beef and less chicken. The demand for chicken will decrease, causing a decrease in the equilibrium price and quantity of chicken. See graph.
Supply and Demand diagram Market for chicken

c. As it happens, the slaughter of beef cattle has coincided with a decrease in consumers' income. Assuming that steak is a normal good while hamburgers are an inferior good, use a supply-and-demand diagram for either market to illustrate the combined effect of the two aforementioned events on the equilibrium price and quantity of hamburgers and steak.

As consumers' income decreases, the demand for normal goods (such as steak) decreases while the demand for inferior goods (such as hamburgers) increases. Keep in mind that our conclusion from part a is still valid. A lower price of beef will increase the supply of all goods in which beef is an input. Therefore in each of the two markets in question we deal with simultaneous shifts in supply and demand.

Steak: S increases, D decreases.   Hamburgers: S increases, D increases.
Supply and Demand diagram   Supply and Demand diagram
The price of steak will decrease. We cannot say for sure what will happen to quantity, since that will depend on the relative magnitude of the two shifts.   The equilibrium quantity of hamburgers sold will increase. We cannot say for sure what will happen to the equilibrium price of a hamburger, since that will depend on the relative magnitude of the two shifts.


3. Assume that the markets for sugar cane, rum, and whiskey are initially in equilibrium. Assume further that Hurricane Marilyn destroys much of the Jamaican sugar cane crop. Sugar cane is a principal ingredient in rum, but it is not an ingredient in whiskey. Analyze the effect of the hurricane on the markets for each of the three goods. Explain using graphs.

Step One - The market for sugar cane
The Hurricane results in a decrease in supply (at any given price, sellers are no longer able to provide as much cane as they used to). As a result, the equilibrium price of sugar cane will increase, and the equilibrium quantity will decrease. See graph.
Supply and Demand diagramMarket for sugar cane

Step Two - The market for rum
Sugar cane is a principal ingredient in rum, and it is now more expensive. An increase in the price of inputs causes a decrease in supply. As a result, the equilibrium price of rum will increase, and the equilibrium quantity will decrease. The graph will be similar to the one above.

Step Three - The market for whiskey
It is reasonable to assume whiskey and rum are substitutes. Rum is now more expensive than it used to be (see Step Two). As a result, more consumers will buy whiskey instead. This will cause an increase in the demand for whiskey, which leads to higher equilibrium price and quantity of whiskey. See graph.

Supply and Demand diagramMarket for whiskey

 


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