question_answer

Good Y is a substitute of good X. The price of Y falls Explain the chain of effects of this change in the market of X.

Or

Explain the chain of effects of excess supply of a good on its equilibrium price.

Answer:

Good Y is a substitute of Good X. If the price of Y falls, then the markert of X will change in the maner that people will diminish its demand. They will consume Good X which is the substitute of Good Y.

For Eg: Tea and Coffee both are the substitutes of each other. If the price of tea falls then the demand for tea will rise and demand for coffee will diminish.

The Chain of effect is shown below:

Let us suppose that the initial equilibrium is at point\[{{E}_{1}}\], where the equilibrium price is \[O{{P}_{1}}\]and the equilibrium output is\[O{{q}_{1}}\].

Now, let us suppose that market supply increases (say, due to a fall in the input prices). This shifts the curve parallel rightwards to \[{{S}_{2}}{{S}_{2}}\] from \[{{S}_{1}}{{S}_{1}}\] with no change in demand at the initial price\[O{{P}_{1}}\], there exist excess supply equals to \[(O{{q}_{1}},\,\,-\,\,O{{q}_{1}})\]units of output. This excess supply will increase competition among the producers and consequently they would be willing to sell their output at a lower price. The price will continue to fall until it reaches\[O{{P}_{2}}\], where, the new supply curve\[{{S}_{2}}{{S}_{2}}\] intersect the initial demand\[{{D}_{1}}{{D}_{1}}\]. The new equilibrium is established at point\[{{E}_{2}}\], where the equilibrium output is \[O{{q}_{2}}\] and the equilibrium price is \[O{{P}_{2}}\] Thus, at the new equilibrium, the equilibrium quantity has risen whereas, the equilibrium price has fallen.