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.

Transcribed Image Text:

Price P₁ P3 P₂ 0 D₁ D₂ S2 Quantity