Question

In the graph below, assume that the original demand and supply curves are given by D₁ and S₁ respectively. Locate the original equilibrium point, identifying both the original equilibrium price and quantity. Now assume that "supply decreases."

1. Graphically, show how this is represented.

2. Locate the new equilibrium point. What happens to the equilibrium price when supply decreases?

3. What happens to the equilibrium quantity?

4. Finally, discuss the idea of price as a rationing device in the context of this example.

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Answer 1

A. The graph is correct. This represents the demand and supply curve.

B. The equilibrium point is that point where D1 and S1 intersect each other.

When supply decreases then the supply curve will shift to its left refer the attached picture below

C. The equilibrium quantity decreases from Qo to Qe.

D. Here resources are limited therefore, the supply decreases as a result of which the prices increased. Further the quantity demanded is high in comparison to the supply therefore it drives the price high. Greater the scarcity of resources higher the price of the product and more the resources are rationed.

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