Question

You have been appointed as an economic advisor to Wheels SA, an organisation that oversees the motor vehicle industry in South Africa. Over the past year, the following simultaneous changes have occurred in the South African motor vehicle market:

• A recently published survey indicates that consumers expect the price of motor vehicles to increase in the future;

• The cost of manufacturing motor vehicles has increased due to an increase in labour costs as well as the costs of other inputs.

Explain, with the use of a graph, the impact of the above changes on the equilibrium price and equilibrium quantity in the motor vehicle market

Answer 1

If consumers expect the prices to go up in future, the demand for the vehicles today will increase. The demand curve will thus shift to the right. Equilibrium price and quantity will increase from $P$ to $P_1$ and $Q$ to $Q_1$ respectively as shown on the graph below:

When the cost of manufacturing motor vehicles increases, supply will decrease. Because the cost of production plus desired profit equals the price of the firm, equilibrium price will rise while equilibrium quantity will reduce as shown on the graph below:

The supply curve shifts to the left. Equilibrium price rises from $P$ to $P_2$ while the equilibrium quantity falls from $Q$ to $Q_2.$