Question

When the supply curve S_x is backward bending and the demand curve Dx is downward sloping as shown in the figure, there are two equilibria M and N, respectively. Which of the following statements is CORRECT?

• A. Only M is stable equilibrium
• B. Only N is stable equilibrium
• C. Both M and N are stable equilibria
• D. Both M and N are unstable equilibria

Answer 1

The Correct Option is B

To understand the stability of equilibrium points M and N in the given supply and demand curves, we need to analyze the characteristics of the curves at these points.

1. **Backward Bending Supply Curve (S_x):** This curve initially slopes upward (positive slope), reaches a maximum, and then bends backward (negative slope).

2. **Downward Sloping Demand Curve (D_x):** This curve slopes downward, which indicates that as price decreases, the quantity demanded increases, following the law of demand.

The intersection points M and N are potential equilibrium points. To determine their stability, we apply the basic concept of equilibrium stability:

• An equilibrium is stable if any small deviation from it leads to forces that move the system back to equilibrium.
• An equilibrium is unstable if any small deviation from it leads to forces that move the system further away from equilibrium.

3. **Analysis of Point M:**

• At point M, the supply curve is sloping downward (backward-bending part), whereas the demand curve is sloping downward.
• This configuration implies that an increase in quantity from M reduces the price, leading suppliers to further decrease quantity (further deviations from M).
• Hence, point M is an unstable equilibrium.

4. **Analysis of Point N:**

• At point N, the supply curve is sloping upward (normal part), while the demand curve continues to slope downward.
• This configuration indicates that any increase in quantity would increase prices, and suppliers would increase supply to restore equilibrium.
• Hence, point N is a stable equilibrium.

Based on the analysis, the correct statement is: Only N is stable equilibrium.