[Related to the Don’t Let This Happen to You on page 96]
A student was asked to draw a demand and supply graph
to illustrate the effect on the market for premium bottled
water of a fall in the price of electrolytes used in some
brands of premium bottled water, holding everything else
constant. She drew the following graph and explained it as
follows:
Electrolytes are an input to some brands of
premium bottled water, so a fall in the price
of electrolytes will cause the supply curve for
premium bottled water to shift to the right
(from S1 to S2). Because this shift in the supply
curve results in a lower price (P2), consumers
will want to buy more premium bottled water,
and the demand curve will shift to the right
(from D1 to D2). We know that more premium
bottled water will be sold, but we can’t be sure
whether the price of premium bottled water
will rise or fall. That depends on whether the
supply curve or the demand curve has shifted
farther to the right. I assume that the effect on
supply is greater than the effect on demand, so
I show the final equilibrium price (P3) as being
lower than the initial equilibrium price (P1).
Explain whether you agree with the student’s analysis. Be
careful to explain exactly what—if anything—you find
wrong with her analysis.