Supply & Demand | Use supply and demand curves to illustrate how each of the following events would affect the price of butter and the quantity of butter bought and sold

Use supply and demand curves to illustrate how each of the following events would affect the price of butter and the quantity of butter bought and sold:

a. An increase in the price of margarine.

b. An increase in the price of milk.

c.  A decrease in average income levels.

ANSWER

a. An increase in the price of margarine.

Butter and margarine are substitute goods for most people. Therefore, an increase in the price of margarine will cause people to increase their consumption of butter, thereby shifting the demand curve for butter out from D₁ to D₂ in Figure 2.2.a. This shift in demand causes the equilibrium price of butter to rise from P₁ to P₂ and the equilibrium quantity to increase from Q₁ to Q₂.

                       

Figure 2.2.a

b. An increase in the price of milk.

Milk is the main ingredient in butter. An increase in the price of milk increases the cost of producing butter, which reduces the supply of butter. The supply curve for butter shifts from
S₁ to S₂ in Figure 2.2.b, resulting in a higher equilibrium price, P₂ and a lower equilibrium quantity, Q₂, for butter.

                       

                               Figure 2.2.b

Note: Butter is in fact made from the fat that is skimmed from milk; thus butter and milk are joint products, and this complicates things. If you take account of this relationship, your answer might change, but it depends on why the price of milk increased. If the increase were caused by an increase in the demand for milk, the equilibrium quantity of milk supplied would increase. With more milk being produced, there would be more milk fat available to make butter, and the price of milk fat would fall. This would shift the supply curve for butter to the right, resulting in a drop in the price of butter and an increase in the quantity of butter supplied.

c.  A decrease in average income levels.

Assuming that butter is a normal good, a decrease in average income will cause the demand curve for butter to decrease (i.e., shift from D₁ to D₂). This will result in a decline in the equilibrium price from P₁ to P₂, and a decline in the equilibrium quantity from Q₁ to Q₂. See Figure 2.2.c.

                              Figure 2.2.c