[murphy560]

Professor Herbener, would you be able to make any general claims about the following scenario: We start with an evenly rotating economy, then the demand for a certain good (good #1) is reduced and shifted to some other good (good #2). We know that the price of good #1 will drop and the production of such a good will become less profitable. Capital will shift from production of good #1 and into good #2. The supply of good #1 will drop and the supply of good #2 will rise. If I am correct so far, what can we say about the new prices of these goods? Of course when the demand originally shifts we can say that good #1 will decrease in price but in the long run do we know whether the price will increase/decrease/stay the same?

[jmherbener]

Assuming a constant money relationship, the price of good #2 would be lower in the long run only if its cost structure fell sufficiently so that production increased its stock relative to the original increase in demand. However unlikely, this might happen if, for example, the extra profit from the original increase in demand for good #2 was used to finance capital investment in a technological breakthrough in producing good #2. Likewise, the price of good #1 would be higher in the long run only if its cost structure rose sufficiently so that production decreased its stock relative to the original decrease in demand.

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