Frank - Macroeconomics Chapter 3 -- Problems

Supply and Demand

1. Substitutes or complements ?
   
   • Tennis courts and squash courts -- Substitutes
   • Squash racquets and squash balls -- Complements
   • Ice cream and chocolate -- Substitutes (unless you think of chocolate syrup for ice cream)
   • Cloth diapers and paper diapers -- Substitutes

2. Shifts of the supply curve for corn
   
   • New, improved crop rotation technique -- lower cost of production, and hence the supply curve shifts downward (an increase in supply.
   • Falling price of fertilizer -- lower cost of production; downward shift; increase in supply.
   • New tax breaks for farmers -- lower cost of production; downward shift; increase in supply
   • Tornado -- higher cost of production (inputs of fertilizer, etc. before the tornado are wasted); hence an upward shift in the supply curve or a reduction in supply.

3. Shifts of the demand curve
   
   • Increase in family income -- demand for vacations increases (demand curve shifts up and to the right), since vacations are a normal good.
   • Beef-heart disease link -- demand for hamburgers decreases (demand curve shifts down and to the left)
   • Relaxation of immigration laws -- more immigration means higher demand for elementary school places; demand curve shifts up and to the right.
   • Increase in the price of audiocassettes on the demand for CDs -- Note that the price increase is an increase in the price of a substitute for CDs -- hence the demand for CDs increases .
   • An increase in the price of CDs on the demand for CDs -- Changes in price DO NOT CHANGE DEMAND . Only the quantity demanded would change, but the original demand curve already shows that.

4. UFO spotting near Tucson
   A report of UFO spottings in the desert near Tucson would certainly affect the demand for binoculars in the area around Tucson;
   it would NOT affect the supply of binoculars at all. Binoculars are made by Zeiss in Germany, and by other companies which would not necessarily have heard of the UFO spottings -- and even if they had, would have no reason to supply more unless the price of binoculars rose. Such a rise in the price of binoculars would lead to a movement along the supply curve, not a shift in the supply curve.

5. Rise in farm workers wages and the supply of oranges
   The rise in the wages of farm workers increases the cost of production of oranges, hence the supply curve shifts up and to the left. Sketch the resulting shift before reading on.
   The equilibrium point moves up and to the left -- a higher equilibrium price and smaller equilibrium quantity will result in the market for oranges.

6. Increase in birthrate and the price of land
   More people means a higher demand for land -- the demand curve shifts up and to the right.
   Sketch the resulting shift before reading on.
   The equilibrium point moves up and to the right -- a higher equilibrium price and a larger equilibrium quantity will result.

7. Fish oil prevents heart disease
   The resulting change in preferences will lead to a higher demand for fisth oil -- hence an increase in demand, and as a result an increase in equilibrium price and an increase in equilibrium quantity.
   The quantity supplied will of course increase as a result of the increase in price, but the supply does not change at all.

8. Market interaction -- chicken feed, price of chicken, demand for beef
   You have to think carefully about the market interactions in this problem.
   An increase in the price of chicken feed results in a rise of the cost of production of chicken; hence a shift upward in the supply curve of chicken. The resulting equilibrium price of chicken will be higher; the equilbrium quantity of chicken will decrease.
   Faced with higher prices of chicken at the supermarket, more consumers will choose substitutes for chicken -- and the demand for beef will increase. The resulting equilbrium price of beef will be higher; the equilbrium quantity of beef will be lower.

9. Auto insurance and demand for autos Note that auto insurance is in economic terms complement to automobiles. You can't have one without the other; hence, when the amount of auto insurance you must buy increases, the cost of driving has gone up.
   The demand for autos will decrease -- that is, the demand curve will shift back.
   Sketching the shift will demonstrate that the equilbrium price of autos will decrease and the equilibrium quantity of autos will also decrease .

   NOTE: Questions 11 through 15 involve the simultaneous shift of demand AND supply curves.
   In these cases, we will be able to predict EITHER the new equilibrium price OR the new equilibrium quantity, BUT NOT BOTH

10. Mad cows and new breeds of chicken
    Mad cow disease will result in a decline in the supply of beef -- the supply curve for beef will shift to the left . As a result the price of beef will rise, and chicken will look more attractive than beef to consumers.
    The demand for chicken increases; the demand curve shifts right on the graph representing the chicken market.
    At the same time, the new breed of chicken costs less to feed; the reduction in cost shifts the supply curve down .
    The increase in demand would tend to pull the price of chicken up; the increase in supply would tend to pull the price of chicken down. Without more information, we cannot tell in which direction the price of chicken would move.
    However, we do know that both an increase in demand and an increase in supply would tend to increase the equilibrium quantity of chicken sold.

11. The price and quantity of potatoes
    The increase in population would tend to increase the demand for potatoes; the higher-yielding variety of potatoes would increase supply.
    Your graph illustrating the potato market should look very much like the previous problem;
    and the conclusion is the same: quantity definitely increases , but we are uncertain what happens to price.

12. The price and quantity of apples
    If apples are discovered to prevent colds, people will be willing to pay more for them; the demand curve (which shows reservation prices or willingness to pay) will shift up; there will be an increase in demand .
    If apple trees are attacked by a fungus, there will be a decrease in supply .
    If supply decreases and demand increases, the new equilbrium quantity is uncertain -- we do not know whether the increase in the quantity demanded at any given price offsets the decrease in the quantity supplied at any price.
    However, both an increase in demand and a decrease in supply would tend to raise the price -- hence the new equilibrium price rises

13. The price and quantity of corn
    Butter is a complement to corn; if the price of butter increases, the price of corn-with-butter increases.
    As a result of a higher price of butter, the demand for corn decreases .
    An increase in the price of fertilizer increases the cost of production of corn; the supply curve shifts up, and the supply of corn decreases.
    A decrease in demand tends to lower price; a decrease in supply tends to raise price, so
    the new equilibrium price of corn is uncertain . However, both the decrease in demand and decrease in supply tend to reduce quantity --
    the new equilibrium quantity of corn certainly decreases .

14. The price and quantity of tofu
    The demand for tofu has been increasing; the change from small-scale to factory-based production has increased the supply of tofu.
    The increase in the demand for tofu would tend to drive up price; the increase in supply would tend to drive down price.
    Hence the new equilibrium price of tofu is uncertain .
    However, both the increase in demand and the increase in supply tend to increase the quantity traded;
    the result will be that the new equilibrium quantity of tofu increases