Answer to Question #129540 in Microeconomics for mathakha

Question

You have been appointed as an economic advisor to the principle of Bright Sparks College, a firm operating in the market for tertiary education. Over the past 18 months the following

simultaneous changes have been noticed in the market for tertiary education:

 A decrease in consumer income;

 An increase in the cost of providing tertiary education services.

Explain, with the aid of a graph, the impact of the above changes on the equilibrium price and equilibrium quantity in the tertiary education market.

Answer 1

The ultimate effect of a simultaneous decrease in consumer income and an increase in the cost of providing tertiary education services is a decrease in quantity demanded for tertiary education services. However, the equilibrium price is most likely to remain unchanged, assuming the two market shocks produce proportional effects on quantity and price through their impact on demand and supply.

A decrease in consumer disposable income is a demand shock; it reduces consumers' purchasing power. The decrease in purchasing power will, ceteris paribus, negatively impact demand - demand falls, and likewise are price and quantity demanded. On the other hand, the increase in the cost of providing tertiary education is a supply shock. It impacts negatively on market supply - supply falls and so is quantity supplied. However, the fall in supply increases market price. Assuming the fall in demand is equal in proportion to the fall in supply, the initial decrease in price accompanied with a fall in demand is compensated by an increase in price arising from a fall in supply. As a result, there is a decrease in the equilibrium quantity and no effect on the equilibrium price. This is shown by the graph below.

On the graph above, the initial demand curve is D0 and the initial supply curve is S0. The demand and supply curve initially establish an equilibrium point at e0 where Q0 is the equilibrium quantity and Pe is the equilibrium price.

The decrease in consumer income results in a downward and leftward movement in demand curve from D0 to D1, as indicated on the graph. Along the new demand curve D1, quantity demanded is reduced at each and every possible price. The point of intersection of D1 and the supply curve S0 shows that both quantity demanded and price had fallen.

The increase in the cost of providing tertiary education results in an upward and leftward movement of the supply curve from the original S0 to S1, as indicated on the diagram. This decrease in supply, further constricts quantity but increases price. This decrease in quantity augments the initial decrease in quantity caused by a fall in demand, however the increase in price compensate the initial decrease caused by a fall in demand.

The two market shocks establishes a new equilibrium at point e1 where the new demand curve D1 interact with the new supply curve S1. The eventual equilibrium quantity is established at Q1 whereas the equilibrium price remains at Pe

Thus, in summary, the given simultaneous market shocks results in a decrease in equilibrium quantity and no effect on equilibrium price.