Demand for new cars decreases at the same time that production costs decrease due to government subsidies to car makers

Q. If demand for new cars decreases at the same time that production costs decrease due to government subsidies to car makers, which of the following would an economist predict would happen?

1. the price of new cars wi definitely increase and the quantity of cars sold will also increase.
2. No new cars will be sold for at least a few months until the market returns to normal.
3. None of the choices is correct
4. both the price and quantity of new cars will definitely increase.
5. the price of new cars will definitely fall, but the quantity of cars sold could go either up or down.

Answer

The price of new cars will definitely fall, but the quantity of cars sold could go either up or down.

Step 1: What is a subsidy

The subsidy is defined as a financial aid given by the government to businesses or individuals to promote social and economic policy. By giving businesses subsidies, the cost of production is decreased.

Step 2: Effect of subsidy on supply

Supply of goods depends so much on the cost of production, therefore, as the cost production decreases, the supply curve shifts rightward. With an increase in supply, the law of demand and supply indicates that the price of the product decreases.

Step 3: Effect of subsidy on equilibrium quantity and equilibrium price

With the subsidy, supply increases above demand which creates a surplus of goods in the market. As this happens when demand increases, the effect will be a fall in equilibrium price but the effect on equilibrium quantity cannot be determined.

Step 4: Why an equilibrium quantity may decrease or increase in the above circumstances

In this case, the price of the good in the short run is solely dependent on the cost of production. With less cost of production, it is obvious that the price will fall eventually. However, the demand the good is dependent on multiple factors other than the price. For instance, the quantity demanded may decrease or increase after a fall in price due to changes in preferences, fashion, the competitiveness of the market.