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Chapter 3: Problem 14

[Related to the Don't Let This Happen to You on page 96\(]\) A student was asked to draw a demand and supply graph to illustrate the effect on the market for premium bottled water of a fall in the price of electrolytes used in some brands of premium bottled water, holding everything else constant. She drew the following graph and explained it as follows: Electrolytes are an input to some brands of premium bottled water, so a fall in the price of electrolytes will cause the supply curve for premium bottled water to shift to the right (from \(S_{1}\) to \(S_{2}\) ). Because this shift in the supply curve results in a lower price \(\left(P_{2}\right)\), consumers will want to buy more premium bottled water, and the demand curve will shift to the right (from \(D_{1}\) to \(D_{2}\) ). We know that more premium bottled water will be sold, but we can't be sure whether the price of premium bottled water will rise or fall. That depends on whether the supply curve or the demand curve has shifted farther to the right. I assume that the effect on supply is greater than the effect on demand, so I show the final equilibrium price \(\left(P_{3}\right)\) as being lower than the initial equilibrium price \(\left(P_{1}\right)\). Explain whether you agree with the student's analysis. Be careful to explain exactly what - if anything- you find wrong with her analysis.

Short Answer

Expert verified
The student correctly identifies that a decrease in the price of electrolytes causes a rightward shift in the supply curve. However, incorrectly states that a lower premium bottled water price will cause a rightward shift in the demand curve. The change in price results in a movement along the demand curve, not a shift in it. The final equilibrium price depending on the elasticity of the demand.

Step by step solution

01

Evaluate Supply Curve Shift

First, the student correctly notes that a decrease in the price of electrolytes, an input used in the production of certain brands of premium bottled water, will cause the supply curve to shift rightward (from \(S_{1}\) to \(S_{2}\)). This is because a fall in cost of input results in increased supply as producers can now produce more at the same cost.
02

Evaluate Demand Curve Shift

However, the part of the student's explanation that is not correct is the assumption that a lower price for premium bottled water (caused by the increase in supply) will cause the demand curve to shift rightward (from \(D_{1}\) to \(D_{2}\)). This is a misunderstanding of the difference between 'movement along the demand curve' and 'shift of the demand curve'. A decrease in price ordinarily leads to an increase in quantity demanded, not an increase in demand. This represents a movement along the demand curve, not a shift in the demand curve.
03

Understanding the Final Equilibrium Price

The student's conclusion about whether the final equilibrium price \(\left(P_{3}\right)\) will be lower or higher than the initial equilibrium price \(\left(P_{1}\right)\) is inconclusive without considering the elasticity of demand. If demand is elastic, a slight decrease in price can lead to a significant increase in quantity demanded, pushing the price back up. However, if the demand is inelastic, even a significant price reduction may not substantially increase the quantity demanded, leaving the price low.

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Most popular questions from this chapter

What do economists mean by shortage? By surplus?

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Years ago, an apple producer argued that the United States should enact a tariff, or a tax, on imports of bananas. His reasoning was that "the enormous imports of cheap bananas into the United States tend to curtail the domestic consumption of fresh fruits produced in the United States." a. Was the apple producer assuming that apples and bananas are substitutes or complements? Briefly explain. b. If a tariff on bananas acts as an increase in the cost of supplying bananas in the United States, use two demand and supply graphs to show the effects of the apple producer's proposal. One graph should show the effect on the banana market in the United States, and the other graph should show the effect on the apple market in the United States. Be sure to label the change in equilibrium price and quantity in each market and any shifts in the demand and supply curves.
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