A student was asked to draw a demand and supply graph to illustrate the effect on the market for smart-watches of a fall in the price of displays used in smart-watches, holding everything else constant. She drew the following graph and explained it as follows:
Displays are an input to smart-watches, so a fall in the price of displays will cause the supply curve for smart-watches 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 smart-watches, and the demand curve will shift to the right (from D1 to D2). We know that more smart-watches will be sold, but we can’t be sure whether the price of smart-watches 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.