FIG 1. 1 a) A scientific report is released which links chocolate consumption to a decrease in heart disease. This first question relates to the issue of demand. In economics we undergo a number of assumptions when considering the relationship between price and quantity demanded. A basic requirement for this approach is to view price as the most important aspect and other factors as constants. We refer to this as the ‘Ceteris Paribus’ (other-things-equal) assumption. The other factors are named the determinants of demand and constitute the “other things equal”.
They are the following: Consumer Tastes, Number of buyers, Income, Prices of Related Goods and Future Expectations. The law of demand, which states an inverse relationship between price and quantity demanded, is based on these assumptions. Should a change occur in one of the determinants of demand, the entire situation changes and the demand curve shifts either to the left or right respectively, depending on whether the change is positive or negative for the product. The market equilibrium occurs at the point where the demand and supply curves intersect- that is, where the quantity demanded is equal to the quantity supplied.
In the case where scientists establish that chocolate decreases the risk of heart disease, this creates a belief in consumers that eating chocolate is healthy. Due to this, consumers gradually change their tastes and preferences towards buying more chocolate at any given price. Thus the general demand increases as the determinant “tastes” does not remain constant. The result, shown as D2 in fig 1. 1, is a rightward shift of the demand curve as this signifies a favorable change in the product’s demand. Graphically we see in fig 1. that both curves intersect further to the right and higher upward, therefore changing both the equilibrium price (which increases from p1 to p2) and the equilibrium quantity (which increases from q1 to q2). The scientific report has thus increased both the equilibrium price and quantity. FIG 1. 2 b) Consumers experience a fall in income. At the same time Brazil experiences a bumper cocoa harvest and there is an increase in the world supply of cocoa. As with demand there are also determinants of supply which need to be considered as ‘Ceteris Paribus’ when we work with relationships involving price and quantity supplied.
They are the following: Resource Prices, Technology, Taxes and Subsides, Prices of Other Goods, Price Expectations and Number of Sellers. As consumer income decreases the “Income” determinant changes thereby decreasing the demand and shifting the demand curve to the left. (labeled D2 in fig 1. 2) Chocolate is a normal good which means that the demand for it varies directly with income. Cocoa is a resource used for the production of chocolate. As the worldwide supply of cocoa increases due to the bumper harvest in Brazil, the resource price for cocoa decreases.
This changes the supply determinant of “resource price” and causes an increase in supply and a rightward shift of the supply curve. (labeled S2 in fig 1. 2) Situations such as this one in which there is a change in both demand and supply are called complex cases. Both increased supply and decreased demand lower the equilibrium price because in both cases the respective curves will intersect at a lower point on the graph in fig 1. 2. The equilibrium price decreases from p1 to p2 on the graph. However the resulting equilibrium quantity cannot be exactly established with the given information.
We can limit the possibilities to two situations: A) If the increase in supply is greater than the decrease in demand – then the equilibrium quantity will increase. (Curves meet at point labeled ‘A’ in fig 1. 2) B) If the decrease in demand is greater than the increase in supply – then the equilibrium quantity will decrease. (Curves meet at point labeled ‘B’ in fig 1. 2) Graphical description: In the first possibility the equilibrium quantity will increase from q1 to q2A and in the latter possibility the equilibrium quantity will decrease from q1 to q2B.