DEMAND AND SUPPLY EXERCISES

1.  Below is the demand and supply for wine grapes in Upper Sonomia, a major wine-producing region of Slobovia.

 Price (Per Ton) Quantity Demanded (Tons per Month) Quantity Supplied (Tons per Month) \$40 2000 500 60 1800 600 80 1600 700 100 1400 800 120 1200 900 140 1000 1000 160 800 1100 180 600 1200 200 400 1300

a.  There will be a shortage of wine grapes at any price [above/below] ___below______ a price of \$ __140___.

b.  There will be a surplus of 300 tons when the price is \$ _160____.

c.  At a price of \$60, there will be a [surplus/shortage] shortage of ____1200___ tons.

d.  Assume that the government decides to help wine consumers by putting a ceiling of \$100 per ton on grapes.  What would happen?  Would the price ceiling be ineffective or would the price ceiling prevail?
At \$100, there is a shortage of 600 tons.  Normally when there is a shortage, buyers bid the price up, but since the government has established a legal maximum price, the shortage persists.

e.  Assume that the government decides to help grape growers by legislating a price floor of \$180 per ton.  What would happen? At \$180, there is a surplus of 600 tons.  When there is a surplus, sellers want to lower their price, but because of the price floor, price cannot drop below \$180.  Therefore, the market will continue to see the surplus.  Grape growers will get a higher price but will not be able to sell all they want to.

f.  If the government were to impose a price ceiling of \$160 per ton, what would happen?  At \$160, there will be a surplus of 300 tons.  Since there is a surplus, they will want to lower their price, which they can do because the price ceiling only sets an upper limit on price.  So price will be lowered until the surplus disappears, which happens at \$140, the equilibrium price.  At this price, quantity demanded equals quantity supplied so the market clears.

2.  Does each of the following events INCREASE, DECREASE, or HAVE NO EFFECT on the DEMAND or SUPPLY of wine in the short run?  Which way does the DEMAND/SUPPLY curve shift?  What determinant has changed?  As you review these answers, you should draw a demand and supply curve and then shift the appropriate curve to see what it looks like.

EXAMPLE:

EVENT:  The price of beer increases.
ANSWER:  The demand for wine will increase.  It shifts to the right. Beer and wine are substitute goods.  When the price of a substitute good falls, the demand for the other good increases.

a.  EVENT:  Government statistics show that average household income is rising.
ANSWER:  Income is a determinant of demand, so a change in income will change (shift) the demand.  The demand for wine will increase.  The demand curve shifts to the right.

b.  EVENT:  Because of advances in gene splicing technology, new healthier varieties of grapes are developed.
ANSWER:  This is a change in technology which affects the supply of wine.  The supply of wine will increase shifting the supply curve to the right.

c.  EVENT:  A private research institute announces that people who drink a glass of wine a day have fewer heart attacks.
ANSWER:  This will change people's tastes and preferences for wine.  Tastes and preferences are determinants of demand.  The demand for wine will increase shifting the demand curve to the right.

d. EVENT:  The price of cheese increases.
ANSWER:  Cheese and wine are complementary goods.  When the price of a complementary good changes, the demand for the other good changes.  If the price of cheese increases, it becomes more expensive to have wine and cheese, so the demand for wine decreases.  The demand curve for wine will shift to the left.

e.  EVENT:  There is a very rainy season causing many grapes to rot on the vine before they have matured.
ANSWER:  This is a change in weather.  It will cause the supply of wine to decrease, shifting the supply curve to the left.

f.  EVENT:  The government begins paying a \$.50 per pound subsidy to wine producers.
ANSWER:  This will lower the cost of producing wine.  A reduction in the cost of production increases the supply.  The supply curve shifts to the right.

3.  This exercise is designed to help you recognize how activity in one market affects what happens in other markets.  In the blanks provided, indicate whether demand, supply, equilibrium price, and equilibrium quantity increase (+), decrease (-), or do not change (0).  If the effect cannot be determined from the information given, use (U).  You should use a supply and demand diagram to help you derive the answers to the questions.  The first one is done for you.

 MARKET EVENT D S P Q a.  Glass Plastic is found to be a cheap substitute for glass in the manufacturing of soft drink containers - 0 - - b.  Poultry Fish becomes scarce and costly AND a university research group invents a quicker way to process chicken. + + U + c.  Hamburger buns The price of hamburger decreases because of an increase in the supply of beef + 0 + + d.  Corn The development of a more effective insecticide for killing rootworm (an insect which destroys corn plants) 0 + - + e.  Used clothing A decrease in consumers' incomes + 0 + + f.  Train Transportation Competition among airlines causes a reduction in air fares - 0 - - g.  Lettuce An increase in the price of irrigation equipment 0 - + - h.  Oranges A freeze in Florida 0 - + -

EXPLANATIONS:

a.  Glass and plastic are substitute goods for the buyer (in this case the buyer is the manufacturer), so a change in the price of plastic will change the demand for glass.  The demand for glass will decrease, shifting the demand curve to the left.  This causes the price of glass to fall and the equilibrium quantity of glass to also fall.

b.  In this problem, two determinants are changing.  1) Fish and poultry are substitutes at the grocery store.  They are substitutes for the buyer.  An increase in the price of a substitute good for poultry will cause the demand for poultry to increase.  2) When the university research group invents a quicker way to process chicken, this is a change in technology which lowers the cost of producing poultry.  This will increase the supply of poultry.

So now we have an increase in the demand for poultry coupled with an increase in the supply of poultry.

Notice that when demand increases, both equilibrium price and quantity increase.  When supply increases, equilibrium quantity increases but equilibrium price falls.  In both cases the equilibrium quantity increases.  But since in one case the equilibrium price increases and in the other, the equilibrium price falls, we cannot say for sure what will happen to the equilibrium price when both demand and supply are increasing.

c.  Hamburger buns and hamburgers are complements.  Changing the price of a complementary good is a determinant of demand.  When the price of hamburgers decreases, buyers can afford more hamburgers and hamburger buns, so the demand for hamburger buns increases.  Demand shifts to the right increasing both the equilibrium price and quantity. (See the graph for an increase in demand above.)

d.  The development of a more effective insecticide is a change in technology which will decrease the cost of production for corn.  The supply of corn will increase (see graph above) which will decrease the equilibrium price and increase the equilibrium quantity.

e.  Used clothing is an inferior good.  A decrease in consumers' incomes (a determinant of demand) will increase the demand for an inferior good. (See the graph for an increase in demand above.)

f.  Air travel and train travel are substitutes for the buyer.  A change in the price of a substitute for the buyer will change the demand for the good in question.  If air fares are cheaper, there will be a decrease in the demand for train transportation, decreasing both equilibrium price and quantity. (See graph for a decrease in demand above.)

g.  Here we have an increase in the cost of production which will reduce the supply of lettuce. Equilibrium price will rise and equilibrium quantity will fall.

h.  A freeze in Florida (weather is a determinant of supply) will decrease the supply of oranges.  Price will rise and quantity will fall.  (See graph above.)