Question

Using graphs show how the effect of a demand shock depends on the shape of supply curve. Consider supply curves that are i.) horizontal ii.) linear upward sloping, iii.) linear downward sloping, iv.) vertical

i.)

ii.)

iii.)

iv.)

3. The Demand for boxes of nails is estimated to be Q=100 - 5p + 2r, where income is measured in thousand of dollars. If p = 4, and r = 10.

a. What is the income elasticity?

b.If the equation is then re-estimated using just dollars instead of thousands of dollars, what will be the effect on the coefficient for Y and the income elasticity?

c. How would the income elasticity change if the price were reduced to $2?

Answer 1

(Question 1)

For the analysis, let us consider a positive demand shock such that demand increases, shifting demand curve rightward. In each of following graph panels, price and quantity are measured vertically and horizontally respectively. D1 is the initial demandcurves intersecting all supply curves at point A with initial price P0 and quantity Q0. For the positive demand shock, D1 shifts rightward to D2.

(i) When supply curve is horizontal as S1, new demand curve (D1) intersects S1 at point B with same price P0 but higher quantity Q1.

(ii) When supply curve is linearly upward sloping as S2, new demand curve (D1) intersects S2 at point C with higher price P2 and higher quantity Q2.

(iii) When supply curve is linearly downward sloping as S3, new demand curve (D1) intersects S3 at point D with higher price P3 but lower quantity Q3.

(iv) When supply curve is vertical as S4, new demand curve (D1) intersects S4 at point E with higher price P4 but same quantity Q0.

Therefore, the flatter (steeper) the supply curve, the higher (lower) the increase in price. When supply curve is vertical (horizontal), quantity (price) remains unchanged but price (quantity) increases for a positive demand shock.

NOTE: As HOMEWORKLIB Answering guideline, first question is answered.