Question

How are equilibrium price and quantity affected when income of the consumers

(a) increase

(b) decrease

Answer 1

(a) Increase in income of consumers

If the number of firms is assumed to be fixed, then the increase in consumers’ income will lead the equilibrium price to rise.

Let us understand how it happens:

D₁D₁ and S₁S₁ represent the market demand and market supply respectively. The initial equilibrium occurs at E₁, where the demand and the supply intersect each other. Due to the increase in consumers’ income, the demand curve will shift rightward parallelly while the supply curve will remain unchanged. Hence, there will be a situation of excess demand, equivalent to (q^e − q₁). Consequently, the price will rise due to excess demand. The price will continue to rise until it reaches E₂ (new equilibrium), where D₂D₂ intersects the supply curve S₁S₁. The equilibrium price increases from P^e to P₂ and the equilibrium output increases from q^e to q₂.

(b) Decrease in the income of consumers

The decrease in consumers’ income is depicted by leftward parallel shift of demand curve from D₁D₁ to D₂ D₂. Consequently, at the price P^e, there will be an execs supply (q^e − q₁), resulting the price to fall. At the new equilibrium (E₂), where D₂D₂ intersect the supply curve, the equilibrium price falls from P^e to P₂ and the equilibrium quantity falls from q^e to q₂.