Under normal downward sloping demand curve and fully elastic supply curve of a commodity, an exogenous decrease in demand would lead to
decrease in equilibrium quantity and no change in price
This question requires us to analyze how changes in market demand affect equilibrium price and quantity when the supply is perfectly elastic and demand slopes downwards.
Understanding Market Equilibrium Dynamics
Market equilibrium is the point where the quantity demanded by consumers equals the quantity supplied by producers. This occurs at the intersection of the demand and supply curves. The price at this intersection is the equilibrium price (\(P_e\)), and the quantity is the equilibrium quantity (\(Q_e\)).
Analyzing the Specific Curves
We are given two specific conditions:
- Downward Sloping Demand Curve: This represents the law of demand, which states that as the price of a good decreases, the quantity demanded increases, and vice versa. Mathematically, the slope is negative (\(\frac{\partial Q_d}{\partial P} < 0\)).
- Fully Elastic Supply Curve: This is a special case where producers are willing to supply any amount of a good at a specific price, but none below it. This results in a horizontal supply curve. Let this fixed supply price be \(P_{supply}\). So, the supply function can be represented as \(P = P_{supply}\). This means \(\frac{\partial Q_s}{\partial P} = \infty\).
Impact of Decreased Demand
An "exogenous decrease in demand" means that consumers want to buy less of the commodity at every possible price. This causes the demand curve to shift to the left.
Let's denote the initial demand curve as \(D_1\) and the new, decreased demand curve as \(D_2\). So, \(D_2\) is to the left of \(D_1\). The supply curve ($S$) remains horizontal at \(P_{supply}\).
Consider the equilibrium:
- Initial Equilibrium: The market initially settles at the intersection of \(D_1\) and $S$. Since $S$ is horizontal at \(P_{supply}\), the initial equilibrium price (\(P_{e1}\)) must be \(P_{supply}\). The initial equilibrium quantity (\(Q_{e1}\)) is determined by the quantity demanded and supplied at this price on \(D_1\).
- New Equilibrium: After the demand decreases, the new equilibrium occurs at the intersection of the new demand curve \(D_2\) and the supply curve $S$. Since the supply curve $S$ is still horizontal at \(P_{supply}\), the new equilibrium price (\(P_{e2}\)) remains \(P_{supply}\). However, because the demand curve has shifted leftward to \(D_2\), the quantity demanded and supplied at the price \(P_{supply}\) is now lower than before. Let this new equilibrium quantity be \(Q_{e2}\). Thus, \(Q_{e2} < Q_{e1}\).
Summary of Effects
The shift of the demand curve to the left, intersecting with a horizontal supply curve, leads to:
- Equilibrium Price: No change. It remains at \(P_{supply}\).
- Equilibrium Quantity: A decrease. It falls from \(Q_{e1}\) to \(Q_{e2}\).
Evaluation of Options
Let's examine the given options based on our analysis:
| Option | Effect on Price | Effect on Quantity | Analysis |
|---|---|---|---|
| 1. increase in equilibrium price and quantity | Increase | Increase | Incorrect. Price remains constant, and quantity decreases. |
| 2. decrease in equilibrium price and quantity | Decrease | Decrease | Incorrect. Price does not change. |
| 3. decrease in equilibrium quantity and no change in price | No change | Decrease | Correct. This matches our analysis. |
| 4. increase in equilibrium price and no change in quantity | Increase | No change | Incorrect. Price does not change, and quantity decreases. |
| 5. | Option 5 is empty. |
The scenario described aligns perfectly with the economic principles of demand and supply shifts when supply is perfectly elastic.
Final Conclusion
Therefore, an exogenous decrease in demand, given a downward sloping demand curve and a fully elastic supply curve, results in a decrease in the equilibrium quantity traded, while the equilibrium price remains unchanged.
Similar Questions
In economics, if a diagram has a line passing through the origin and has a 45° angle with either axis and it is asserted that along the line, X = Y, what is tacitly assumed?
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3. Barriers to entry
4. Homogeneous products
Select the correct answer using the code given below:
Which one of the following is not an assumption in the law of demand?
Which one of the following statements is not correct?
Which one of the following does not influence quantity demanded for a good?
The value of the slope of a normal demand curve is ________.
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Important Questions from Microeconomics
Which of the following statement is correct?
I. Indifference curves are sloping from left to right.
II. Higher indifference curve gives a higher level of utility.
According to Ricardo what condition is necessary to make possible international trade between two countries?
Match List I with List II:
List- I
Shape of revenue curve of the firm
List – II
Market structure
A.
Kinked revenue-curve (I)
Monopolistic competition B.
Infinitely elastic straight line curve (II)
Perfect competition C.
Relatively less elastic curve (III)
Oligopoly D.
Relatively high elastic curve (IV)
Monopoly.
Choose the correct answer from the options given below -Marginal revenue of a firm is constant throughout under _________.
The cost curve which is a rectangular hyperbola is:
