2. Supply and Demand

Question 1

What are characteristics of “competitive markets”?

Answer 1

• Large number of buyers and sellers
• Homogeneous good/service
• Nothing a firm does has an effect on the price
• Nothing a buyer does has an effect on the price
• “Buyers and Sellers are Price Takers”

Question 2

What is the definition of a “competitive market”?

Answer 2

“Place where large numbers of buyers and sellers of goods and services meet and act independently. No firm is big enough to influence the price.”

Question 3

What does the “demand curve” show?

Answer 3

illustrates the quantity of a good / service consumers want to purchase at different prices, ceteris paribus,

Question 4

What is the “law of demand”?

Answer 4

Law of demand: other things being equal (ceteris paribus), the higher is the price of a good, the lower will be the demand for it

Question 5

How do shifts in the demand curve happen?

Answer 5

Shifts of the demanded curve take place when there is a change in the quantity demanded of a good at any given price

Question 6

What are the non price determinants of demand?

Answer 6

• Changes in income
• Prices of substitutes
• Prices of complements
• Preferences
• Future price expectation
• Change in size of population

Question 7

How do “changes in income” shift the demand curve?

Answer 7

Normally, if a consumer has more income he is more likely to buy a good at any given price

!! However, for some goods, demand will decrease when income increases These are called inferior goods For these goods an increase in income will result in a shift of the demand curve to the left !!

Question 8

How do “changes in preferences” shift the demand curve?

Answer 8

If people develop a preference for MacBooks, then demand for MacBooks will increase

Question 9

How do “changes in expectations” shift the demand curve?

Answer 9

If people expect the price of houses to fall in the future, then demand for houses will decrease now at any given price (people will wait to buy them later, at lower prices) demand curve will shift to the left

Question 10

How does “price of substitutes” shift the demand curve?

Answer 10

If the two goods are substitutes, then a rise in the price of one good leads to an increase in demand for the other good

E.g. if price of Coca Cola goes up, demand for Pepsi increases if price of tube tickets goes down, demand for bus tickets decreases

Question 11

How does “price of complements” shift the demand curve?

Answer 11

If the two goods are complements, then a rise in the price of one good leads to a decrease in demand for the other good

E.g. if the price of washing machines goes down, demand for washing powder goes up

Question 12

What does the “demand curve” show?

Answer 12

illustrates the quantity of a good / service producers want to provide at different prices, holding constant all other things that may influence supply (e.g. input costs and technology)

Question 13

What is the “law of supply”?

Answer 13

Other things being equal, the higher the price of a good, the larger the quantity producers will be interested in supplying

Question 14

What are the factors that shift the supply curve?

Answer 14

• Costs of production - Indirect taxes
• Subsidies
• Technological change
• Expectations of future prices
• Number of suppliers

CISTEN

Question 15

How does “costs of production” shift the supply curve?

Answer 15

E.g. water, sugar & lemons to produce lemonade If the price of an input increases it will be more costly to supply the good. Thus, sellers are less willing to supply the good at any given price supply curve will shift to the left

Question 16

How do “changes in technology” shift the supply curve?

Answer 16

Improvements in technology reduce the quantity of inputs necessary to obtain a given amount of a good, resulting in a reduction in the cost of production

E.g. the set of activities that lemons, water & sugar into lemonade

Question 17

How do “changes in future price expectations” shift the supply curve?

Answer 17

Supply of a good is affected not only by current circumstances, but also by what people expect to happen in the future.

E.g. if house sellers expect the price of houses to rise in the future, then supply for houses will decrease now at any given price (they will wait to sell them later, at higher prices)

Question 18

What is the definition of “market equilibrium”?

Answer 18

A competitive market will be in equilibrium when price is such that the quantity demanded equals the quantity supplied

Question 19

What is “excess supply”?

Answer 19

When Qs exceeds Qd. (usually because of a price floor)

Question 20

What is “excess demand”?

Answer 20

When Qd exceeds Qs. (usually because of a price ceiling)

Question 21

What is present when the market price is above the equilibrium price?

Answer 21

If market price is above equilibrium price, there will be an excess supply of the good, which will cause market price to fall until it reaches the equilibrium level

Question 22

What is present when the market price is below the equilibrium price?

Answer 22

If market price is below equilibrium price, there will be an excess demand of the good (i.e. a shortage), which will cause market price to rise until it reaches the equilibrium level

Question 23

Some exceptions:

Answer 23

1st = London housing

2nd = software, eg. spotify

3rd = Perfectly inelastic demand, no matter the price the demand stays the same

4th = Perfectly elastic demand, the demand only exists at one price