Chapter 4 Problem and Application Microeconomic

CHAPTER 4: THE MARKET FORCE OF DEMAND AND SUPPLY 1. Explain each of the following statements using supply and demand diagrams a. When a cold snap hits Florida, the price of orange juice rises in supermarkets throughout the country Cold weather damages the orange crop, reducing the supply of oranges. This can be seen in Figure 6 as a shift to the left in the supply curve for oranges. The new equilibrium price is higher than the old equilibrium price. b. When the weather turns warm in New England every summer, the price of hotel room in Caribbean resorts plummets People often travel to the Caribbean from New England to escape cold weather, so demand for Caribbean hotel rooms is high in the winter. In the summer, fewer people travel to the Caribbean, since northern climes are more pleasant. The result, as shown in Figure 7, is a shift to the left in the demand curve. The equilibrium price of Caribbean hotel rooms is thus lower in the summer than in the winter, as the figure shows. c. When a war breaks out in the Middle East, the price of gasoline rises and the price of used Cadillac falls. When a war breaks out in the Middle East, many markets are affected. Since much oil production takes place there, the war disrupts oil supplies, shifting the supply curve for gasoline to the left, as shown in Figure 8. The result is a rise in the equilibrium price of gasoline. With a higher price for gasoline, the cost of operating a gas-guzzling automobile, like a Cadillac, will increase. As a result, the demand for used Cadillacs will decline, as people in the market for cars will not find Cadillacs as attractive. In addition, some people who already own Cadillacs will try to sell them. The result is that the demand curve for used Cadillacs shifts to the left, while the supply curve shifts to the right, as shown in Figure 9. The result is a decline in the equilibrium price of used Cadillacs. 2. An increase in the demand for notebooks raises the quantity of notebooks demanded but not the quantity of supply. Is this true or false? Explain The statement that "an increase in the demand for notebooks raises the quantity of notebooks demanded, but not the quantity supplied," in general, is false. As Figure 10 shows, the increase in demand for notebooks results in an increased quantity supplied. The only way the statement would be true is if the supply curve was a vertical line, as shown in Figure 11. 3. Over the past 40 years, technological advances have reduced the cost of computer chips. How do you think this has affected the market for competers? Form computer software? For typewriters? Technological advances that reduce the cost of producing computer chips represent a decline in an input price for producing a computer. The result is a shift to the right in the supply of computers, as shown in Figure 16. The equilibrium price falls and the equilibrium quantity rises, as the figure shows. Since computer software is a complement to computers, the lower equilibrium price of computers increases the demand for software. As Figure 17 shows, the result is a rise in both the equilibrium price and quantity of software. Since typewriters are substitutes for computers, the lower equilibrium price of computers reduces the demand for typewriters. As Figure 18 shows, the result is a decline in both the equilibrium price and quantity of typewriters. 4. Using supply and demand diagrams, show the effect of the following events on the market for sweatshirts. a. A hurricane in South Carolina damages the cotton crop When a hurricane in South Carolina damages the cotton crop, it raises input prices for producing sweatshirts. As a result, the supply of sweatshirts shifts to the left, as shown in Figure 19. The new equilibrium has a higher price and lower quantity of sweatshirts. b. The price of leather jackets falls A decline in the price of leather jackets leads more people to buy leather jackets, reducing the demand for sweatshirts. The result, shown in Figure 20, is a decline in both the equilibrium price and quantity of sweatshirts c. All colleges require morning exercise in appropriate attire The effects of colleges requiring students to engage in morning calisthenics in appropriate attire raises the demand for sweatshirts, as shown in Figure 21. The result is an increase in both the equilibrium price and quantity of sweatshirts. d. New knitting machines are invented The invention of new knitting machines increases the supply of sweatshirts. As Figure 22 shows, the result is a reduction in the equilibrium price and an increase in the equilibrium quantity of sweatshirts. 5. Ketchup is a complement (as well as a condiment) for hot dogs. If the price of hotdog rises, what happens in the market for ketchup? For tomatoes? For tomato juice? For orange juice? Since ketchup is a complement for hot dogs, when the price of hot dogs rises, the quantity demanded of hot dogs falls, thus reducing the demand for ketchup, causing both price and quantity of ketchup to fall. Since the quantity of ketchup falls, the demand for tomatoes by ketchup producers falls, so both price and quantity of tomatoes fall. When the price of tomatoes falls, producers of tomato juice face lower input prices, so the supply curve for tomato juice shifts out, causing the price of tomato juice to fall and the quantity of tomato juice to rise. The fall in the price of tomato juice causes people to substitute tomato juice for orange juice, so the demand for orange juice declines, causing the price and quantity of orange juice to fall. Now you can see clearly why a rise in the price of hot dogs leads to a fall in price of orange juice! 6. Because bagels and cream cheese are often eaten together, they are complements. a. We observe that both the equilibrium price of cream cheese and the equilibrium quantity of bagels have risen. What could be responsible for this pattern – a fall in the price of flour or a fall in the price of milk? If the price of flour falls, since flour is an ingredient in bagels, the supply curve for bagels would shift to the right. The result, shown in Figure 27, would be a fall in the price of bagels and a rise in the equilibrium quantity of bagels. Since cream cheese is a complement to bagels, the fall in the equilibrium price of bagels increases the demand for cream cheese, as shown in Figure 28. The result is a rise in both the equilibrium price and quantity of cream cheese. So, a fall in the price of flour indeed raises both the equilibrium price of cream cheese and the equilibrium quantity of bagels. What happens if the price of milk falls? Since milk is an ingredient in cream cheese, the fall in the price of milk leads to an increase in the supply of cream cheese. This leads to a decrease in the price of cream cheese (Figure 29), rather than a rise in the price of cream cheese. So a fall in the price of milk could not have been responsible for the pattern observed. b. Suppose instead that the equilibrium price of cream cheese has risen but the equilibrium quantity of bagels has fallen. What could be responsible for this pattern – a rise in price of flour or a rise in the price of milk? In part (a), we found that a fall in the price of flour led to a rise in the price of cream cheese and a rise in the equilibrium quantity of bagels. If the price of flour rose, the opposite would be true; it would lead to a fall in the price of cream cheese and a fall in the equilibrium quantity of bagels. Since the question says the equilibrium price of cream cheese has risen, it could not have been caused by a rise in the price of flour. What happens if the price of milk rises? From part (a), we found that a fall in the price of milk caused a decline in the price of cream cheese, so a rise in the price of milk would cause a rise in the price of cream cheese. Since bagels and cream cheese are complements, the rise in the price of cream cheese would reduce the demand for bagels, as Figure 30 shows. The result is a decline in the equilibrium quantity of bagels. So a rise in the price of milk does cause both a rise in the price of cream cheese and a decline in the equilibrium quantity of bagels.