1. If consumers expect the price of some good to rise next week, then we generally observe the price of the good rising this week. Explain this fact using a graph.
If the good is storable, and an increase in price is expected, consumers will want to buy the good today, before the price increases. As a result, the current demand for the good increases, which results in an increase in the price of the good today. See graph.
2. The drought in the plain states has made grain, and therefore feed, quite expensive. Many ranchers cannot afford to feed their cattle, and have sold much of their herd for slaughter.
a. What will be the immediate effect of this event on the equilibrium price and quantity of beef? Illustrate using a supply and demand diagram.
Slaughtering the cows will result in an increase in the supply of beef to the market, which will in turn lead to a decrease in the equilibrium price of beef and an increase in the equilibrium quantity of beef. See graph.
b. Chicken and beef are substitute goods. Illustrate the effect that the slaughter of the cattle herds will have on the equilibrium price and quantity of chicken.
As the price of beef decreases, consumers will buy more beef and less chicken. The demand for chicken will decrease, causing a decrease in the equilibrium price and quantity of chicken. See graph.
c. As it happens, the slaughter of beef cattle has coincided with a decrease in consumers' income. Assuming that steak is a normal good while hamburgers are an inferior good, use a supply-and-demand diagram for either market to illustrate the combined effect of the two aforementioned events on the equilibrium price and quantity of hamburgers and steak.
As consumers' income decreases, the demand for normal goods (such as steak) decreases while the demand for inferior goods (such as hamburgers) increases.
Keep in mind that our conclusion from part a is still valid. A lower price of beef will increase the supply of all goods in which beef is an input. Therefore in each of the two markets in question we deal with simultaneous shifts in supply and demand.
3. Assume that the markets for sugar cane, rum, and whiskey are initially in equilibrium. Assume further that Hurricane Marilyn destroys much of the Jamaican sugar cane crop. Sugar cane is a principal ingredient in rum, but
it is not an ingredient in whiskey. Analyze the effect of the hurricane on the markets for each of the three goods. Explain using graphs.
Step One - The market for sugar cane
The Hurricane results in a decrease in supply (at any given price, sellers are no longer able to provide as much cane as they used to). As a result, the equilibrium price of sugar cane will increase, and the equilibrium quantity will decrease. See graph.
Step Two - The market for rum
Sugar cane is a principal ingredient in rum, and it is now more expensive. An increase in the price of inputs causes a decrease in supply. As a result, the equilibrium price of rum will increase, and the equilibrium quantity will decrease. The graph will be similar to the one above.
Step Three - The
market for whiskey
It is reasonable to assume whiskey and rum are substitutes. Rum is now more expensive than it used to be (see Step Two). As a result, more consumers will buy whiskey instead. This will cause an increase in the demand for whiskey, which leads to higher equilibrium price and quantity of whiskey. See graph.