Question

U.S. agricultural farmers are excited since the government announced an increase in subsidies even though the substitutes for agricultural goods that are imported have increased in demand; therefore, please illustrate by constructing a supply and demand graph, the direction in which the curves will shift and state the new equilibrium price and quantity; for example, state whether price and quantity increased, decreased, or are indeterminate. Please explain your rationale based on the determinants of demand and supply.

Answer 1

Increase in subsidy will lower the effective production cost, so farmers will increase output, increasing market supply. The supply curve will shift rightward, decreasing price and increasing quantity. At the same time, higher demand for imported substitutes will decrease the demand for domestic agricultural goods, decreasing market demand. The demand curve will shift leftward, decreasing price and decreasing quantity. The net effect is a definite decrease in price. But quantity will be higher, lower or unchanged on basis of whether the rightward shift in supply curve is higher than, lower than or equal in magnitude to the leftward shift in demand curve.

In following graph, D0 and S0 are initial demand and supply curves intersecting at point A with initial price P0 and quantity Q0. As D0 shifts left to D1 and S0 shifts right to S1, they intersect at point B with lower price P1 and new quantity Q1.

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