Supply & Demand Practice Question

01
of 07

Supply & Demand Practice Question - The Question

Seven-A-Day Fruit And Vegetables Recommended Intake
Christopher Furlong / Getty Images

Our supply and demand question is as follows:

Illustrate each of the following events using a demand and supply diagram for bananas:

  • Reports surface that some imported bananas were infected with a virus.
  • Consumers' income drop.
  • The price of bananas rises.
  • The price of oranges falls.
  • Consumers expect the price of bananas to increase in the future.

In the next section, we will examine how you begin to answer such a supply and demand question.

02
of 07

Supply & Demand Practice Question - The Setup

In any supply and demand question that begins with phrases such as:

"Illustrate each of the following events.."

"Show what happens when we have the following changes.."

we need to compare our situation to a base case. Since we're not provided with numbers here, we don't have to make our supply/demand graphic very specific. All we need is a downward sloping demand curve and an upward sloping supply curve.

Here I've drawn a basic supply and demand chart, with the demand curve in blue and the supply curve in red. Note that our Y-axis measures price and our X-axis measures quantity. This is the standard way of doing things.

Note that our equilibrium occurs where supply and demand cross. Here this is denoted by the price p* and the quantity q*.

In the next section, we will answer part (a) of our demand and supply question.

03
of 07

Supply & Demand Practice Question - Part A

Illustrate each of the following events using a demand and supply diagram for bananas:

Reports surface that some imported bananas were infected with a virus.

This should certainly reduce the demand for bananas as they are now far less desirable to consume. Thus the demand curve must shift down, as shown by the green line. Note that our equilibrium price is lower along with our equilibrium quantity. Our new equilibrium price is denoted by p*' and our new equilibrium quantity is denoted by q'*.

04
of 07

Supply & Demand Practice Question - Part B

Illustrate each of the following events using a demand and supply diagram for bananas:

Consumers' income drop.

For most goods (known as "normal goods"), when people have less money to spend, they buy less of that good. Since consumers now have less money they're likely to buy fewer bananas. Thus the demand curve must shift down, as shown by the green line. Note that our equilibrium price is lower along with our equilibrium quantity. Our new equilibrium price is denoted by p*' and our new equilibrium quantity is denoted by q'*.

05
of 07

Supply & Demand Practice Question - Part C

Illustrate each of the following events using a demand and supply diagram for bananas:

The price of bananas rises.

The question here is: Why did the price of bananas rise? It could be because the demand for bananas has increased, causing both the quantity consumed and the price to rise.

Another possibility is that the supply of bananas has decreased, causing the price to rise but the quantity consumed to decrease.

In the diagram I've drawn, I have both effects taking place: The demand has risen and the supply has dropped. Note that only having one of these effects is sufficient to answer the question.

06
of 07

Supply & Demand Practice Question - Part D

Illustrate each of the following events using a demand and supply diagram for bananas:

The price of oranges falls.

There are a couple of different things that could happen here. We will assume that oranges and bananas are substitute goods. We know that people will buy more oranges because the price is lower. This has two effects on the demand for bananas:

We should expect that consumers switch from buying bananas to buying oranges. Thus the demand for oranges should fall. Economists call this "the substitution effect"

There is a second less obvious effect here, though. Since the price of oranges has fallen, they will now have more money in their pocket after purchasing the same quantity of oranges as before. Thus they can spend this extra money on other goods, including more oranges and more bananas. So the demand for bananas could actually rise due to what economists call "the income effect". It is called this because the price drop allows consumers to purchase more, similar to when they have a rise in income.

Here I have assumed that the substitution effect overpays the income effect, thus causing the demand for bananas to fall. It is not incorrect to assume the opposite, but you should indicate in writing why you drew the curve where you did.

07
of 07

Supply & Demand Practice Question - Part E

Illustrate each of the following events using a demand and supply diagram for bananas:

Consumers expect the price of bananas to increase in the future.

For the purposes of this question, we will assume that the future means the very near future. Such as tomorrow.

If we knew there was going to be a big jump in the price of bananas tomorrow, we would make sure to make our bananas purchases today. So the demand for bananas today would increase.

Note that this increase in demand causes the price of bananas to increase today. So the anticipation of a future price hike will often cause a rise in price today.

Now you should be able to answer supply & demand questions with confidence. If you have any question, you can contact me by using the feedback form.