Question

Draw a labeled graph showing the supply and demand curves. Mark P, and Q. on your graph. Then show an increase in supply (as opposed to an increase in the quantity supplied.) Mark P2 and Q2 on your graph. 2. Suppose the market is initially in equilibrium. Then, demand decreases while supply decreases, the equilibrium price will and the equilibrium quantity A) Rise; will increase B) Rise; is ambiguous/indeterminate C) Drop; is ambiguous/indeterminate D) Ambiguous/indeterminate; will fall

Answer 1

1. The supply and demand curves are depicted in the image below.

2. When both demand and supply decrease simultaneously, the effect on equilibrium price and quantity is ambiguous and indeterminate.

The decrease in demand tends to put downward pressure on price, as there is less demand for the product leading to a lower equilibrium price. Also, the decrease in supply tends to put upward pressure on price, as there is now less of the product available in the market which can lead to a higher equilibrium price.

The net effect on equilibrium price depends on the relative magnitude of the decrease in demand compared to the decrease in supply. If the decrease in demand is greater, the price may fall; if the decrease in supply is greater, the price may rise and if they are roughly equal, the price may remain relatively stable or change only slightly.