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1. Consider the market for new cars. e. Suppose the U.S. Environmental Protection Agency announces it...

1. Consider the market for new cars.

e. Suppose the U.S. Environmental Protection Agency announces it will require new light trucks and sport utility vehicles (SUVs) to install pollution control devices that will increase their cost. How will the supply and demand curves (if either) for cars be affected? (Assume cars and SUVs are considered different goods.) What will happen to the equilibrium price and quantity of cars?

f. Consider the difference between the short run of a few days or weeks and the long run of a few months or years. Suppose the price of gasoline goes up. How will the supply and demand curves be affected in the short run? What will happen to the equilibrium price and quantity of cars?

g. In the long run, how would your answer to part f. change?

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Installation of pollution control devices will increase the price of cars (SUVs are types of cars only). This will make it costly for consumers to afford SUVs and they will start looking for other options. As a result of this, demand for SUV cars will fall, shifting the demand curve to the left. Keeping supply unchanged, this will lead to a fall in both price and quantity sold of cars in the market Short run effect An increase in price of gasoline will make car travel costly (since gas and cars are complementary goods used together). Thus, demand for cars will fall immediately in the short run. Keeping supply unchanged, this will lead to a fall in both price and quantity sold of cars g) Long run effect As price of cars falls, car producers will start reducing their production of cars, since they do not wish to sell cars at lower prices and reduce their profit margins. This will lead to a fall in supply of cars, shifting supply curve to the left Combined with the short run effect, this leads to an increase in price of cars back to the initial price level, quantity of cars however, falls even further

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