Use supply and
demand curves to illustrate how each of the following events would affect the
price of butter and the quantity of butter bought and sold:
a. An increase in the price of margarine.
b. An increase in the price of milk.
c. A decrease in average income levels.
ANSWER
a. An increase in the price of margarine.
Butter and margarine are substitute goods for most people. Therefore, an increase in the price of margarine will cause people to increase their consumption of butter, thereby shifting the demand curve for butter out from D1 to D2 in Figure 2.2.a. This shift in demand causes the equilibrium price of butter to rise from P1 to P2 and the equilibrium quantity to increase from Q1 to Q2.
Figure 2.2.a
b. An increase in the price of milk.
Milk is the main ingredient in butter. An
increase in the price of milk increases the cost of producing butter, which
reduces the supply of butter. The supply curve for butter shifts from
S1 to S2 in Figure 2.2.b, resulting in a
higher equilibrium price, P2 and a lower equilibrium
quantity, Q2, for butter.
Figure 2.2.b
Note: Butter is in
fact made from the fat that is skimmed from milk; thus butter and milk are
joint products, and this complicates things. If you take account of this
relationship, your answer might change, but it depends on why the price of milk
increased. If the increase were caused by an increase in the demand for milk,
the equilibrium quantity of milk supplied would increase. With more milk being
produced, there would be more milk fat available to make butter, and the price
of milk fat would fall. This would shift the supply curve for butter to the
right, resulting in a drop in the price of butter and an increase in the
quantity of butter supplied.
c. A
decrease in average income levels.
Assuming that butter is a normal good, a decrease in average income will cause the demand curve for butter to decrease (i.e., shift from D1 to D2). This will result in a decline in the equilibrium price from P1 to P2, and a decline in the equilibrium quantity from Q1 to Q2. See Figure 2.2.c.
Figure 2.2.c
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