2: Competitive markets: demand and supply

Question 1

What was the original nature of markets?

Answer 1

A physical meeting place where buyers and sellers meet face to face with a bartering system.

Question 2

What is the evolved definition of a market?

Answer 2

Any kind of arrangement where buyers and sellers of goods, services and resources are linked together to carry out an exchange.

Question 3

What are the two different markets and what is sold in them?

Answer 3

Goods and services are sold in product markets whilst resources (factors of production) are sold in resource markets (factor markets).

Question 4

What is competition? What is it in microeconomics?

Answer 4

The process whereby rivals compete in order to achieve some objective. In microeconomics competition occurs when there are many buyers and sellers acting independently, so that no one has the ability to influence the price at which a product is sold in the market.

Question 5

What is market power?

Answer 5

Also known as monopoly power, which is the control that a seller may have over the price of the product it sells. The greater the market power, the greater the influence over the price.

Question 6

What is demand?

Answer 6

The demand of an individual consumer indicated the various quantities of a good (or service) the consumer is willing and able to buy at different possible prices during a particular time period, ceteris peribus.

Question 7

What do willing and able mean?

Answer 7

Willing means the consumer wants to buy the good and able means the consumer can afford to buy it.

Question 8

What does ceteris peribus mean?

Answer 8

It simply means all else remaining the same, in the case of demand ceteris peribus means that all things other than the price that can affect how much the consumer is willing and able to buy are assumed to be constant and unchanging.

Question 9

What is the law of demand?

Answer 9

The law of demand states a negative, causal relationship between the price of a good and quantity demanded over a particular time period, ceteris peribus. As the price of the good increases, quantity demanded falls, ceteris peribus.

Question 10

Why is the shape of the demand curve as such?

Answer 10

Due to the principle of decreasing marginal benefit: since marginal benefit falls as quantity consumed increases, the consumer will be induced to buy each extra unit only if the price falls.
Also income effect and substitition effect.

Question 11

What is market demand?

Answer 11

The sum of all the individual demands for a good. The market demand curve illustrates the law of demand, shown by the negative relationship between price and quantity demanded, ceteris peribus. The market demand is also the sum of comsumers’ marginal benefits.

Question 12

What does a shift in the demand curve suggest? What does left and right mean?

Answer 12

A non price determinant of demand has changed. Rightward means an increase in demand and leftward means a decrease.

Question 13

What are the non price determinants of demand?

Answer 13

• Income
• Substitute products
• Compliments in consumption
• Changes in population
• Normal/inferior goods
• Preferences

Question 14

Distinguish between a movement along and a shift in the demand curve:

Answer 14

A movement along the demand curve indicated a change in the price of the good itself, thereby changing quantity demanded. A shift in the demand curve indicates a change in non price determinants, changing the demand.

Question 15

What is the definition of supply?

Answer 15

The supply of an individual firm indicates the various quantities of a good or service a firm is willing and able to produce and supply to the market for sale at different possible prices, during a particular time period, ceteris peribus.

Question 16

What is the law of supply?

Answer 16

The law of supply states a positive causal relationship between price and quantity supplied, over a particular time period, ceteris peribus.

Question 17

Why is the supply curve sloped upward?

Answer 17

Higher prices generally mean that the firms profits increase, and so the firm faces an incentive to produce more output.

Question 18

What is market supply?

Answer 18

Market supply is the sum of all individual firms’ supplies for a good. The market supply curve illustrates the law of supply, shown by a positive relationship between price and quantity supplied, ceteris peribus.

Question 19

What does a vertical supply curve indicate?

Answer 19

Even as price increases, the quantity supplied cannot increase; it remains constant, meaning the quantity supplied is independent of price. For example there is a fixed quantity of theatre tickets due to a fixed number of seats in that period of time.

Question 20

Why would there be a vertical supply curve?

Answer 20

Either:

1. There is a fixed quantity of the good supplied because there is no time to produce more of it.
2. There is a fixed quantity of the good because there is no possibility of ever producing more of it, for example antique Stradivarius violins.

Question 21

Non price determinants for supply?

Answer 21

1. Cost of production (-)
2. Technology (+)
3. Compliments in production/joint supply (-) e.g. diesel and diesel
4. Expectations of future price (-)
5. Taxes (-)
6. Subsidies (+)
7. Number of firms (+)
8. Unpredictable events (-)

Question 22

Distinguish between the movement along a supply curve and the shift of a supply curve:

Answer 22

Any change in price produces a change in quantity supplied, shown as a movement on the supply curve. Any change in a non price determinant produces a change in supply, shown by a shift of the whole supply curve.

Question 23

What happens when supply is greater than demand?

Answer 23

The producers will lower the price gradually, causing quantity supplied to fall and quantity demanded to increase due to the laws of supply and demand. Eventually it reaches a point where quantity demanded is equal to quantity supplied and the surplus is eliminated. This is the equilibrium price.

Question 24

What happens when demand is greater than supply?

Answer 24

Producers will notice that the good is quickly being sold out and so they will raise the price. As they raise the price quantity supplied will increase and quantity demanded will fall. Eventually they will be equal at the equilibrium price.

Question 25

What does it mean for a market to be in equilibrium?

Answer 25

When a market is in equilibrium, quantity demanded equals quantity supplied, and there is no tendency for the price to change. In a market disequilibrium, there is excess demand (shortage) or excess supply (surplus) and the forces of demand and supply cause the price to change until the market reaches equilibrium.

Question 26

What is the demand function equation?Sy

Answer 26

Qd = a-bP

Qd = quantity demanded
P = price
a = the horizontal intercept of the curve (where the line meets Qd) 
-b = the slope

Question 27

How can we use the demand function?

Answer 27

In paper 3 they will give you an equation, say it is Qd = 14-2P. From this you can figure out Qd by inserting several prices, starting with P = 0 then increasing until 5.

Question 28

What will happen to the demand curve if the demand curve function changes?

Answer 28

If a changes then there will be a parallel shift of the demand curve. If -b changes the steepness of the curve will change as -b represents the slope.

Question 29

How does the number representing -b effect the slope exactly?

Answer 29

The greater the absolute value of the slope, the flatter the demand curve.

Question 30

What is the supply function equation?

Answer 30

Qs = c + dP

Qs = quantity supplies
P = price
c = horizontal/x intercept
d = the slope

Question 31

How do you calculate the slope?

Answer 31

∆Q/∆P

Question 32

What will happen to the supply curve if the supply curve function changes?

Answer 32

If c changes, it is a shift. If d changes, the slope changes.

Question 33

What if the c value in the supply function is negative?

Answer 33

This just means it starts from a negative value, but you do not see this as it is impossible to have a negative value for quantity supplied.

Question 34

How does the number representing d effect the slope exactly?

Answer 34

The greater the value of the slope, the flatter the curve.

Question 35

How can you use linear equations to calculate equilibrium price and quantity?

Answer 35

If you are given the supply function and demand function, the equilibrium price can be calculated by setting the equal to each other and solving for P. Then plug this P value back into the equations to find Q, which should be the same for Qd and Qs, test this.

Question 36

How can you plot demand and supply curves from linear functions to find EQ and EP?

Answer 36

You plot several points and draw the curves. Then you find where they intersect.

Question 37

What is the role of price in the allocation of resources?

Answer 37

Prices are signals and incentives. As signals, prices are used to communicate information to decision-makers. As incentives, prices motivate decision makers to respond to the information.

Question 38

What is the meaning of efficiency in competitive markets?

Answer 38

The competitive market realises allocative efficiency, producing the combination of goods most wanted by society. It also means productive efficiency involving production with the fewest possible resources.

Question 39

What is consumer surplus? How is it shown on a graph?

Answer 39

Consumer surplus is the highest price consumers are willing to pay for a good minus the price actually paid. It is shown on a graph by the shaded area between the demand curve and the equilibrium price.

Question 40

What is producer surplus? How is it shown on a graph?

Answer 40

Producer surplus is the price received by firms for selling their good minus the lowest price that they are willing to accept to produce the good.

Question 41

What is marginal cost?

Answer 41

The lowest price that a firm is willing to accept to produce the good.

Question 42

What is social surplus?

Answer 42

The sum of consumer and producer surplus.

Question 43

When is social surplus maximised? What does this mean?

Answer 43

At the point of competitive market equilibrium. This means at competitive market equilibrium, markets are achieving allocative and productive efficiency.

Question 44

If markets are achieving efficiency at competitive market equilibrium, why is government intervention ever necessary?

Answer 44

Efficiency can only arise under a number of strict and unrealistic conditions that are never met in the real world. Market failures occur. In addition market equilibrium does not answer the for whom to produce question as income distribution is unequal which leads to inequity.