CHAPTER 2
THE BASICS OF SUPPLY AND DEMAND

QUESTIONS FOR REVIEW

1. Suppose that unusually hot weather causes the demand curve for ice cream to shift to the right. Why will the price of ice cream rise to a new market-clearing level?

Assume the supply curve is fixed. The unusually hot weather will cause a rightward shift in the demand curve, creating short-run excess demand at the current price. Consumers will begin to bid against each other for the ice cream, putting upward pressure on the price. The price of ice cream will rise until the quantity demanded and the quantity supplied are equal. [pic]
Figure 2.1

2. 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.

Most people consider butter and margarine to be substitute goods. 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 will cause the equilibrium price to rise from P1 to P2 and the equilibrium quantity to increase from Q1 to Q2. [pic]

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 will increase the cost of producing butter. The supply curve for butter will shift from S1 to S2 in Figure 2.2.b, resulting in a higher equilibrium price, P2, covering the higher production costs, and a lower equilibrium quantity, Q2.
[pic]

Figure 2.2.b

Note: Given that butter is in fact made from the fat that is skimmed off of the milk, butter and milk are joint products. If you are aware of this relationship, then your answer will change. In this case, as the price of milk increases, so