Intermediate Economics

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This question refers to a market in which quantity demanded is given by $q = a - bp$ and quantity supplied by $q = c + dp$.

In this market, an increase in the parameter $a$ would:

a. increase quantity and decrease price.

b. decrease both price and quantity.

c. increase both price and quantity.

d. increase price and decrease quantity.

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There are 2 best solutions below

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One of the tenets of economics is that in equilibrium $$Supply=Demand$$ Both supply and demand are functions of price. So in order to find an equilibrium we need find a price that satisfy the above equation. If supply and demand equations are well-behaved (i.e., supply equation increasing in price and demand equation decreasing in price) then there is a unique equilibrium price such that demand=supply.

So in your case $$ a-bp = c+dp$$

Solving this equation for $p$ you obtain $$ p = \frac{a-c}{b+d} $$ Note that the price needs to be non-negative and finite, which imposes restrictions on the parameters. Assuming that $b,d>0$ so that demand and supply functions are well behaved, we have requirement that $a-c>0$.

We can now answer your question. Differentiating $p$ wrt $a$ we obtain $$\frac{\partial p}{\partial a} = \frac{1}{b+d}>0$$

Therefore, equilibrium price increases following an increase in $a$. Moreover, since equilibrium $p$ increases, the supply function implies that the equilibrium quantity will increase as well.


So answer C is correct: Both equilibrium price and equilibrium quantity will increase.

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If $a$ increases to $a'$, the Demand function $D$ goes to $D'$ and the equilibrium point $E$ goes to $E'$; that is both quantity and price increase.

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