Answer to Question #205562 in Economics of Enterprise for Nawodya Ranasinghe

Question

8.2 Graphically express what effect will each of the following have on the supply of auto tires?

I. A technological advance in the methods of producing tires.

 

II.An increase in the prices of rubber used in the production of tires. 

III.The levying of a per-unit tax on each auto tire sold.

 

IV.The granting of a 50-cent-per-unit subsidy for each auto tire produced. (1*4=4 marks) 

Answer 1

i. Improvement in production techniques cum technology gives the tire firm the edge to increase her productivity hence increase output and consequently increased supply of tires as graphically illustrated below; a shift in the supply to the left from S to S₁ denotes the effect of technological advancement on the supply of tires.

 

 

ii. A rise in the price of rubber, which is a major input in tire production, increases the cost of production, this leads reduction in the profit margins of the firms hence discouraging its (tire) production leading to reduced supply. The graph below illustrates the effect of an increase in the cost of production (increase in the price of rubber) of tires the supply of the same; the shift to the left, from S to S_1, hence reduction in quantities supplied from Q to Q₁.

iii) The introduction of the levying of a per-unit tax on each auto tire will affect both the sellers and the consumers buyers. The seller is at the discretion to bear the tax burden by reducing the profit margin while keeping the prices of goods stable or pass it onto the consumers by raising the price by the size of the tax levy; discouraging demand in the long run. Both endeavors have adverse effects and end up discouraging either the manufacturers or consumers (lowering demand), making the entire industry uneconomical (profitable). This is likely to result in reduced supply, in the long run as illustrated in the graph below:

iii) Subsidies are financial assistance offered by the government to meet part of the production cost, hence encouraging the production of the product(s) in question by enabling manufacturers to maintain their profit margin while maintaining prices as low as possible to cushion consumers. Granting a pre unit of 50cents subsidy will encourage more production of auto-tires since manufacturers can produce more for less. The impact of a subsidy is to reduce price while increasing output (supply) as illustrated in the graph below: