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Sales Slump
Subject Comparative statics
Topic Utility and Consumer Choice
Key Words Sales, growth, inflation, recession, interest rates, budgets, prices
News Story

Sales are growing modestly. In June, sales rose 2.8 percent, compared to 6.7 percent in the same stores a year before, and 4.7 percent in May. The trend was seen across each store category - national department stores, specialty retailers, discount stores, and warehouse clubs.

Retail analysts attribute the slower growth to the Fed's attempts to restrain the economy to reduce the risk of inflation, but without causing a recession. Since June 1999, the Fed has raised interest rates by 1.75 points. At the same time, sky-rocketing gas prices have led to smaller discretionary budgets.

The downward trend in sales growth is expected to continue over coming months. July may be a clearance month to create space for Fall and back-to-school items.

(Updated September 1, 2000)

Questions

1. a) Draw a diagram with axes representing the quantity of gasoline and the quantity of all other goods and services. Add a consumer's budget line and an indifference curve that is tangent to the budget line. Mark the equilibrium quantities of gasoline and other goods and services bought by consumer.

b) Incomes have continued to grow. Show the effect of this on the consumer's equilibrium. What happens to the equilibrium quantities of gasoline and other goods and services that are bought by the consumer?

c) Assuming that rising interest rates have not affected the price of gasoline, but have increased the effective price of other goods and services (because financing is more expensive), draw what has happened to the budget line. Mark clearly what has happened to the consumer's equilibrium.

d) Now show the effect of higher gas prices by moving the budget line. Again, illustrate what has happened to the equilibrium.

2. a) Overall, what has happened to the quantity of other goods and services as a result of these changes?

b) What might happen if the Fed increased interest rates dramatically?

Source Lorrie Grant, "Retailers report slowing sales," USA Today, July 7, 2000.

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