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Difficulty: MediumDeterminants and Changes in Demand

A government policy introducing a heavy subsidy on electric vehicles leads to a widespread reduction in their retail market price. Consequently, consumer purchasing patterns alter, causing a noticeable drop in the market demand for petrol-powered cars at every price level. Which of the following correctly describes how this economic event affects the market demand curve for petrol-powered cars?

  1. An inward (leftward) shift of the demand curve, because electric vehicles and petrol-powered cars are substitute goods in competitive demand.Answer
  2. B
    An upward movement along the existing demand curve, reflecting a decrease in the quantity demanded of petrol-powered cars.
  3. C
    An outward (rightward) shift of the demand curve, because electric vehicles and petrol-powered cars are complementary goods in joint demand.
  4. D
    A downward movement along the existing demand curve, reflecting an increase in the quantity demanded of petrol-powered cars.

Answer

An inward (leftward) shift of the demand curve, because electric vehicles and petrol-powered cars are substitute goods in competitive demand.
Electric vehicles and petrol-powered cars are substitute goods in competitive demand. When the price of electric vehicles drops due to subsidies, consumers substitute away from petrol-powered cars. Because this change is triggered by a non-price determinant (price of a substitute good) rather than a change in the price of petrol-powered cars themselves, the market demand for petrol-powered cars decreases at every price point, causing an inward (leftward) shift of its demand curve.

Step-by-Step Solution

1
Identify the relationship between the two goods described in the scenario.
Electric vehicles and petrol-powered cars are substitute goods (competitive demand) because consumers choose between them to fulfill similar transportation needs.
Determining whether goods are substitutes or complements dictates the direction of the demand change when the price of one changes.
2
Analyze the impact of a price decrease in the substitute good on the target commodity's market.
A fall in the price of electric vehicles makes them relatively cheaper, causing consumers to switch away from petrol-powered cars, reducing overall demand for petrol-powered cars.
Cross-price elasticity for substitutes is positive: a decrease in the price of Good X leads to a decrease in demand for Good Y.
3
Distinguish between a change in quantity demanded and a change in demand.
Since the change is driven by a non-price determinant (the price of a substitute) rather than the price of petrol-powered cars itself, the effect is represented by a leftward (inward) shift of the demand curve.
Price changes of the good itself cause movements along the curve, while non-price factors cause shifts of the entire curve.

Key Concept

Impact of Substitute Good Prices on Demand Curve Shifts
Estimated Time:1m 0s
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Topics

Determinants and Changes in Demand

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