Cheena was discussing with her friend Meena that if the market for cotton is in equilibrium and suddenly both market demand and market supply decreases. Then what will happen? Meena said Effect on price will be uncertain. Is she right? If yes, why? If no, why?
Answer & explanation
Correct answer: option 4
The correct answer is Option 4: Yes, depends on magnitude of shift
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When both demand and supply decrease, the new equilibrium quantity will definitely decrease because fewer buyers are demanding the good, and fewer sellers are supplying it.
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However, the effect on price is uncertain and depends on which shift (demand or supply) is larger:
- If the decrease in demand is greater than the decrease in supply, the price will fall.
- If the decrease in supply is greater than the decrease in demand, the price will rise.
- If both decrease by the same magnitude, the price remains unchanged.
Since the price outcome depends on the magnitude of the shifts, Meena is correct.