Question

Examine the effect of (a) fall in the own price of good X and (b) rise in tax rate on good X, on the supply curve. Use diagrams.

Answer 1

(a) A decline in the own price of Good X shows a positive relationship with the supply of good. When the price declines from P₁ to P₂, there will be contraction of supply from Q₁ to Q₂. Hence, the supply curve will move downwards.

(b) Assuming other things remain constant, the levy of a tax on Good X shows a negative relationship with the supply of a good. When there is a tax on a good, the cost of production increases and decreases the profit of the producer. Hence, it leads to a decrease in the supply of a good which shifts the supply curve towards the left, i.e. S₂S₂ to S₁S₁.