Theory question 107
Price Determination(a) Distinguish between competitive demand and joint demand.
(b) Using diagrams, explain how the following factors will affect the equilibrium price and quantity of commodity R in the market: (i) an increase in the price of the complement of commodity R; (ii) an increase in the price of a substitute of commodity R; (iii) imposition of an indirect tax on commodity R.
Show the model answer
(a) Competitive demand is demand for goods that are substitutes (e.g. tea and coffee): a rise in the price of one raises demand for the other. Joint demand is demand for goods used together (e.g. car and petrol): a rise in the price of one reduces demand for both.
(b)(i) Dearer complement: demand for R falls; D shifts left; equilibrium price and quantity of R both fall.
(ii) Dearer substitute: demand for R rises; D shifts right; equilibrium price and quantity of R both rise.
(iii) Indirect tax: supply of R falls; S shifts left (upwards by the tax); equilibrium price rises and quantity falls.
Each diagram shows the original and new curves with the old and new equilibrium price and quantity.
Ask whether the factor shifts demand or supply, and in which direction.