Question

Suppose that the demand for a drug is perfectly inelastic and the market is initially in equilibrium. Suppose further that there is an increase in the price of an input required to produce of the drug. Everything else held constant, graphically (and in words) illustrate the impact of this action in the market for this drug. What will happen to equilibrium price and equilibrium quantity? How would your answer be different if demand was not perfectly inelastic? (7 points) 4.

Answer 1

Perfectly inelastic demand means buyer are ready to demand same quantity at different price level. If demand is perfectly elastic and price of input rises, producer cost of production rises as a result SS curve ie., supply curve shift to the left and new supply curve is S'S' . Due to decrease in supply price of drugs will increase and since demand is perfectly inelastic then quantity will remain same as shown in the graph at OQ.

If demand curve is not perfectly inelastic then it will be downward sloping and supply curve is upward sloping so initial equilibrium is at point E .

Initial price is OP and Initial quantity is OQ.

Now is price of input rises then supply curve shifts to the left as a result equilibrium point increases to OP1 and equilibrium quantity decreases to OQ1.

This will happen because now demand is negatively related with the price so as price increases demand for drugs tend to decrease. Therefore equilibrium quantity will also decrease.