02 - Basic Economic Principles

Question 1

How are price(P1) and quantity demanded(Q1) related to each other?

Answer 1

They are negatively related, and their relationship defines the demand curve for a given good or service

ex. As the price falls, households will increase the quantity consumed

Question 2

What is quantity demanded(Q1)?

Answer 2

The total amount of a commodity that all households wish to buy at a given price

This variable is affected by changes in:
1) The price of the commodity
2) Average household income
3) Price of related commodities (complimentary vs. substitutes)
4) Consumer tastes
5) Distribution of income (expensive items are only available to a smaller group of wealthy people)
6) Population size

Question 3

What happens to the demand curve when demand increases or decreases?

Answer 3

An increase in demand shifts the entire curve to the right

A decrease in demand shifts the entire curve to the left

Question 4

What happens when firms successfully meet demand?

Answer 4

When they meet demand, price remains the same. If firms over-supply, the price decrease, while undersupply results in increased prices

Question 5

How does household income affect demand?

Answer 5

Increasing household income usually shifts the demand curve for goods to the right (more is demanded at every price)

a) Demand for Normal Goods increases with increases in income (ex of a normal good: electronics). The curve shifts to the right (demand increases)

b) Demand for Inferior Goods decreases with increases in income (fewer sales of KD, tube steak, and rental apartments) The curve shifts to the left (demand decreases)

c) Demand for Superior Goods increases disproportionately more than increases in income (ex of a superior good: healthcare). The curve shifts much more to the right (demand increases)

Question 6

What is a complementary good, and how is its demand affected by changes in price?

Answer 6

A complementary good is a product or service that adds value to another (ex. cereal and milk)

If the price of a complimentary good(cereal) increases, the demand curve of related goods(milk) will shift to the left (demand decreases)

Question 7

What is a substitute good, and how is its demand affected by changes in price?

Answer 7

Substitute goods are similar products that offer consumers the same purpose.

If the price of a substitute(natural gas) increases, the demand curve of an alternate good (heating oil) will increase. The demand curve of the substitute good(natural gas) will shift to the right (demand increases)

Question 8

How do consumer preferences (taste) affect demand?

Answer 8

If preferences for a product increase, then the demand curve shifts to the right (demand increases)

Question 9

How does population size affect demand?

Answer 9

If the population seeking the product increases, then the demand shifts to the right (demand increases)

Question 10

How does price and quantity supplied relate to each other?

Answer 10

For most commodities, price and quantity produced will be related positively

As the price of a commodity rises, firms increase how much they produce and new firms will enter the market.

Question 11

What is the quantity supplied, and what factors affect it?

Answer 11

The amount of a commodity that firms want to supply at a given price

The quantity supplied is determined by:
1) The price of the commodity
2) The cost of production (inputs)
3) The state of technology
4) The goals of the firm

Question 12

How does the supply curve shift in response to increases or decreases in supply?

Answer 12

If supply increases, the supply curve shifts to the right

If supply decreases, the supply curve shifts to the left

Question 13

How does the cost of production affect supply?

Answer 13

As cost of production increases, the supply curve shifts to the left (decrease supply)

If cost of production decreases, the supply curve shifts to the right (increase supply)

Question 14

How does technological change affect supply?

Answer 14

If improvements in technology reduce costs, the supply curve shifts to the right (increase supply)

Question 15

How do the goals of a firm affect supply?

Answer 15

Firms that choose to seek greater market share will increase supply (shift supply curve to the right), while firms that want to maximize profits will reduce supply (shift supply curve to the left)

Question 16

How is the price of a good or service determined in the market?

Answer 16

The price is based on the independent actions of many buyers (households) and sellers (firms), each acting in their own interests

Question 17

What is special about the intersection of the supply and demand curves?

Answer 17

It represents the point known as the equilibrium price, a price at which forms are willing to produce is equal to the quantity that households are willing to purchase. Any price changes will result in a return to the equilibrium price defined by the intersection of the demand and supply curves at a given time.

Question 18

What does the term “clearing the markets” mean?

Answer 18

This occurs when the equilibrium price is achieved, and as a result, there is no excess supply or demand. (Both parties have everything they need. Buyers have goods, and sellers have sales)

Question 19

What is elasticity in the context of economics?

Answer 19

Refers to the extent that quantity demanded or supplied changes relative to the price.

Question 20

How to tell if a given product or service is subject to elastic demand?

Answer 20

Demand for a product is elastic if a price change results in a proportionally larger change in quantity demanded. (ex. demand for coffee is elastic, small changes in price cause larger changes in quantity demanded by consumers)

Question 21

What is inelastic demand?

Answer 21

Demand for a product is said to be inelastic if a change in price results in a proportionally smaller change in quantity demanded.

(ex demand for gasoline is inelastic, large changes in price do not proportionately affect quantity demanded. People have to drive regardless if gas is cheap or expensive)

Question 22

What factors subject a good to elastic or inelastic demand?

Answer 22

Necessary vs. unnecessary (more necessary = more inelastic ex. gas)
Cost to consumer (low cost = more inelastic ex. paper)
Availability of substitutes (fewer substitutes = more inelastic ex. natural gas for heating)

Question 23

Who benefits from inelastic demand, and what does this party do to ensure inelasticity?

Answer 23

Suppliers prefer inelastic demand

They use advertising to decrease inelasticity by creating a necessity for their product and parent consumers from going to other competitors.

Question 24

What is elastic supply?

Answer 24

Supply of a product is said to be elastic if a change in price results in a proportionally larger change in quantity supplied.

(ex. When the price of potash decreases, firms can store it and wait for prices to increase, they effectively limit supply)

Question 25

What is inelastic supply?

Answer 25

Supply of a product is said to be inelastic if a change in price results in a proportionally smaller change in quantity supplied.

(ex. When the price of fresh fruit decreases, firms cannot store it and are forced to sell fruit even if it is at a loss)

Question 26

What factor decides the elasticity of supply?

Answer 26

An elastic supply curve is more common with non-perishable goods or when the firm does not require cash. (Firms can stockpile and wait for prices to rise)

An inelastic supply curve is more common with perishable goods or when firms are strapped for cash. (Firms are not able to stockpile and accept today’s price regardless)

Question 27

How does elasticity change for a given product over time?

Answer 27

Over the short-term, demand and supply curves tend to be inelastic due to the lack of suitable substitutes or production factors that cannot be easily changed (ex. buying gas when prices are high)

Over the long run, these curves tend to become more elastic as households and forms react to existing prices (ex. people start taking public transport more frequently)