Question 9: How are equilibrium price and quantity affected when income of the consumers
a) Increase
b) Decrease
Answer:
(a) Increase in income of consumers If the number of firms is assumed to be fixed, then the increase in consumers’ income will lead the equilibrium price to rise. Let us understand how it happens: D1D1 and S1S1 respect the market demand and market supply respectively. The initial equilibrium occurs at E1, where the demand and the supply intersect each other. Due to the increase in consumers’ income, the demand curve will shift rightward parallelly while the supply curve will remain unchanged. Hence, there will be a situation of excees demand, equivalent to (qe-q1). Consequently, the price will continue to rise until it reaches E2 (new equilibrium), where D2D2 intersects the supply curve S1S1. The equilibrium price increases from Pe to P2 and the equilibrium output increases from qe to q2.
(b) Decrease in the income of consumers The decrease in consumer income is depicted by leftward parallel shift to demand curve from D1D1 to D2D2. Consequently at the price Pe there will be an execs supply (qe-q1) resulting the\ price of falls from Pe to P2 and the equilibrium quantity falls qe to q2.
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