What would happen in the market for car tires if there was an increase in the price of rubber used to produce tires and a decrease in the price for cars? Explain the effects on price and quantity.

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As prices decrease, demand increases. A drop in the price for cars will increase the demand for cars and, therefore, sales of cars. The question assumes that increases in tire prices, which would drive up new car prices, still result in a net decrease in car prices. As new car sales increase, the demand for tires would increase, as well, further driving up tire prices.

At some point, given consistent supply, there would be equilibrium in the marketplace for cars as tire prices rise to offset the reduction in new car prices. But there is more to this than the effect on new car prices and tires that come equipped on new cars.

There is a market for tires outside the new car market. As tire prices rise, one would expect demand for new replacement tires to slacken as people delay buying new tires while prices are high. In addition, more people would be likely to buy used tires from retired vehicles, and patch or retread their current tires to save money. This slackening in the replacement tire market would offset, to an unknown degree, the tire supply issues created by increasing new car sales. In other words, as demand for replacement tires wanes, there would be more tires available for new cars, which would tend to stabilize prices. So far, though, there has been no accounting for relative demand inflexibility. When tires wear out, people need new tires if there are insufficient used and/or repair options. While demand would decrease as prices increase, there would be a floor below which demand would not fall unless tire prices became prohibitively expensive. It is likely, though, that demand for less-expensive tires would increase, while demand for premium tires would decrease.

The interaction with the new car market, therefore, would not be symmetrical, since increased demand for inexpensive tires would drive up the price of those tires while slackening demand for expensive tires would tend to reduce their price. If factories could both read market movement in, and change product output in, real time, there would be rapid adjustment in the supply of inexpensive and expensive tires to meet shifting market demand, but the real world usually doesn't work this way.

Instead, there would be at least a temporary imbalance in the supply of, and demand for, tires of various quality and price. It would be reasonable to expect premium tires to decrease in price to draw down inventories because of slackening demand, and for inexpensive tires to increase in price as demand creates shortages. To the degree that tire manufacturers can increase the overall supply, given the availability of raw materials, manufacturing capacity, and profit targets, they would most likely increase supply for inexpensive tires as long as elevated prices lasted.

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To start, I will make a graph for the initial state of tire supply and demand. This graph has supply and demand curves in red, with a positive supply curve and a negative demand curve.

If the cost of rubber increases, then the cost for a supplier to make a tire will increase as well. If the supplier wants to make the same amount of profit per tire, this pushes up the price at which tires are sold.

If the cost of a car goes down, more people will purchase cars. If more people have cars, demand for tires will increase.

This means the supply of tires will decrease, and demand for tires will increase. When I move the curves on my graph with new green curves, it shows the equilibrium price of tires increasing, but little change in equilibrium quantity.

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