Question 1 (8 marks) using supply-and-demand diagrams, show and explain the effect of the following events on the market for woolen Jumpers. An outbreak of ‘foot-and-mouth’ disease hits farms In Australia. (2 marks) Supply curve shifts left Whenever there is an outbreak of foot-and-mouth’ disease in Australian farms, the result is an increase to the input prices for producing woolen jumpers. As a consequence, the supply of woolen Jumpers shifts to the left on the graph, as shown below.
The new equilibrium price is higher and the new equilibrium quantity of jumpers is lower.
The price of leather Jackets falls (2 marks) Demand curve shifts left When the price of leather jackets falls, more people buy them, which In turn reduces the demand for Jumpers. The result, shown on the graph below, Is a decline In both the equilibrium price and quantity of woolen Jumpers. Kylie Mingle, an Australian born international pop star, appears in a woolen jumper in her latest video. (2 marks) Demand curve shifts right As so many people have the desire to look like Kylie, the effect Kylie Mingle would have on the demand for woolen Jumpers, by wearing one in her video, would be very positive.
The demand for jumpers would rise.
As shown below, the result is an increase in both the equilibrium price and quantity of Jumpers. New knitting machines are Invented (2 Marks) Supply curve shifts right The invention of new knitting machine would have the effect of increasing the supply of woolen jumpers. As shown below, the result would be a reduction in the equilibrium price and an increase in the equilibrium quantity of jumpers.
Question 2 (6 marks) Find the flaws in the in reasoning in the following statements, paying particular attention to the distinction between shifts of and movements along the demand and apply curves.
Draw a diagram to illustrate what actually happens. “A technological revolution that lowers the cost of producing a good might at first result In a reduction In the price of the good to consumers. But a fall In price will Increase demand for the good, and higher demand will send the price up again. It Is not certain, therefore, that an innovation will really reduce price in the end. ” (3 marks) This statement lowers the cost of producing the good, leading producers to offer more of the good at any given price. This is represented by a rightward shift of the supply curve from SSL o SO.
As a result, the equilibrium price falls and the equilibrium quantity rises, as shown by the change from El to E. The statement “but a fall in price will increase demand for the good, and higher demand will send the price up again” is incorrect for the following reasons.
A drop in price does increase the quantity demanded and leads to an increase in the equilibrium quantity as one moves down along the demand curve, it does not however, lead to an increase in demand-?a rightward shift of the demand curve-?and therefore does not cause the price to increase again.
A study shows that eating a clove of garlic a day can help prevent heart disease, causing consumers to demand more garlic. This increase in demand results in a rise in the price of garlic. Consumers, seeing that the price of garlic has gone up, reduce their demand for garlic.
This causes the demand for garlic to decrease and the price of garlic to fall. Therefore, the ultimate effect of the study on the price of garlic is uncertain. ” (3 marks) This statement also confuses a shift of a curve with a movement along a curve.
The health report generates an increase in demand-?a rightward shift f the demand curve from ODL to DO. This leads too higher equilibrium price and quantity as we move up along the supply curve, and the equilibrium changes from El to E.
The following statements are wrong: “Consumers, seeing that the price of garlic has gone up, reduce their demand for garlic. This causes the demand for garlic to decrease and the price of garlic to fall. ” This statement is incorrect as they imply that the rise in the equilibrium price causes the demand for garlic to decrease-?a leftward shift of the demand curve.
A rise in the equilibrium price via a movement long the supply curve does not cause the demand curve to shift leftward.
Question 3 (6 marks) Many small boats are made of fiberglass, which is derived from petroleum. Suppose the price of crude oil rises. Illustrate and explain what happens to the cost curves of an individual boat building firm and to the market supply curve? (3 marks) The rise in the price of crude oil increases production costs for individual firms and therefore shifts the industry supply curve up, as shown in the diagram below. The firm’s initial marginal-cost curve is MIMIC and its average-total-cost curve is ATTIC .
In the initial equilibrium, the industry supply curve, SSL, intersects the demand curve at price Pl , Inch is equal to the minimum average total cost of the typical firm. Thus, the typical firm earns no economic profit. Explain what happens to the (3 marks): Profits of boat builders in the short run? TACT, and shifts the industry supply curve up to SO. The equilibrium price rises from Pl to PI, but the price does not increase by as much as the increase in marginal cost for the firm.
As a result, price is less than average total cost for the firm, which would result in a loss for the firm.