What is the combined effect of an increase in the cost of production and a rise in consumer income on the equilibrium price and quantity of a normal good? A The effect on price is indeterminate but quantity will fall. B The effect on price is indeterminate but quantity will rise. C The effect on quantity is indeterminate but price will rise. D The effect on quantity is indeterminate but price will fall. Can someone explain why the answer is C? I would have thought that they are both indeterminate. A rise in income means the demand curve for a normal good shifts to the right. Without a change in price, the demand will increase. However, how do we know how the firm will react to an increase in the cost of production? Will a firm automatically increase price as cost of production increases? I understand that if this is the case then equilibrium quantity is interderminate, but I would have thought that equilibrium price is indeterminate as well. If production costs raise by 1p, will price raise too? Surely not. Thanks
The reason why the answer is C is because when the income inreases, consumers may or may not spend more on purchases hence the the change in quantity is indeterminate. The increase in price is ofcourse as a result of the increase in cost. Producers will definitely increase price to cover the increase in costs. Hope that answers you !
Isn't the definition of a normal good that its demand increases as income increases? I didn't realise that an increase in production costs always gives rise to an increase in price. Thanks
Yes, higher income shifts demand curve to the right/up. Higher production costs shifts the supply curve to the left/up. Basically less profit at each price point so inclined to produce less at a particular price. Equilibrium price is where the two curves meet. Since both curves move up, there is definitely a higher price but whether the quantity moves left or right depends on the relative sizes of the moves in demand/supply
