2 - Supply and Demand

Question 1

What is Qd?

Answer 1

The quantity demanded is the amount of a good that consumers are willing to buy at a given price during a specified period, holding constant other factors which influence Qd..

Question 2

What is the main factor which potential consumers base their decisions on?

Answer 2

Price

Question 3

What 6 other main factors influence consumer decisions?

Answer 3

• Consumer tastes
• Information
• Income
• Prices of substitutes
• Prices of complements
• Government action

Question 4

What does the demand function show?

Answer 4

The correspondence between the Qd, price, and other factors that influence purchases.

Question 5

What would a typical demand function describing what consumption depends on look like?

Answer 5

Qd = D(p,ps,pc,Y)

Question 6

What would a typical demand function describing that consumption depends on price, price of substitutes, price of complements and income look like?

Answer 6

Q = constant - ap + bps - cpc + dY

Question 7

Why is the price (of the good in question) variable of a demand function always negative?

Answer 7

Because of the law of demand, Qd and P are negatively related.

Question 8

Why is the price of a close substitute variable of a demand function always positive?

Answer 8

Because as the price of the close substitute rises, the good in question seems more attractive and vice versa.

Question 9

Why is the price of a complementary good variable of a demand function always negative?

Answer 9

As the price of the complement rises, the good in question becomes more expensive and vice versa. It acts as the price of the good itself does.

Question 10

Why is the income variable of a demand function always positive?

Answer 10

Because income is always positive.

Question 11

Why do economists hold constant the effects of some factors?

Answer 11

So that they can determine how an individual variable affects Q.

Question 12

How do economists hold constant the effects of some factors?

Answer 12

By taking partial derivatives.

Question 13

How can we graphically show the relationship present within a given demand function?

Answer 13

With a demand curve.

Question 14

What is a demand curve?

Answer 14

A plot of the demand function that shows the quantities demanded at each possible price, holding other factors constant.

Question 15

How is a change in a product’s price reflected on a demand/supply curve?

Answer 15

As a movement along the curve.

Question 16

What is the law of demand?

Answer 16

Consumers demand more of a good the lower its price, holding constant other factors that influence the amount they consume.

Question 17

What is a mathematical way of stating the law of demand?

Answer 17

The derivative of the demand function with respect to price is negative.

Question 18

Why does dQd/dP illustrate the law of demand?

Answer 18

Because the derivative of the demand function with respect to price shows the movement along the demand curve as price varies.

Question 19

How is the slope of the demand curve related to the derivative of the demand function with respect to price?

Answer 19

The slope of the demand curve is the reciprocal of the derivative of the demand function.

Question 20

Why is the slope of the demand curve the reciprocal of the derivative of the demand function?

Answer 20

Because we put price on the vertical axis and quantity on the horizontal axis.
slope = dp/dQ = 1/(dQ/dp)

Question 21

What causes the demand curve to shift?

Answer 21

A change in any factor other than the price of the good itself.

Question 22

How do we represent the addition of one demand/supply curve to another graphically?

Answer 22

By summing the Q’s horizontally.

Question 23

What is Qs?

Answer 23

The quantity supplied is the amount of a good that firms want to sell during a given period at a given price, holding constant other factors which influence Qs.

Question 24

What is the main factor which potential producers base their decisions on?

Answer 24

Price

Question 25

What 2 other main factors influence producer decisions?

Answer 25

• Production cost

- Government rules and regulation

Question 26

What does the supply function show?

Answer 26

The correspondence between the Qs, price, and other factors that influence the number of units offered for sale.

Question 27

What would a typical supply function describing what consumption depends on look like?

Answer 27

Qs = S(p,pc)

Question 28

What would a typical supply function describing that production depends on price and costs of production look like?

Answer 28

Q = constant + ap - bpc

where pc is the price of a major input into production.

Question 29

Why is the production cost variable of a supply function always negative?

Answer 29

Because as the cost of production rises, the good in question generates less profit and vice versa.

Question 30

How can we graphically show the relationship present within a given supply function?

Answer 30

With a supply curve.

Question 31

What is a supply curve?

Answer 31

A plot of the supply function that shows the quantities supplied at each possible price, holding other factors constant.

Question 32

What is a main difference in the law of supply from the law of demand?

Answer 32

There is no “law of supply” which requires the supply curve to have a particular slope.

Question 33

What are the possible supply curve slopes?

Answer 33

The market supply curve can be upward sloping, vertical, horizontal or downward sloping.

Question 34

How can we determine how far a supply/demand curve shifts as a variable other than price changes?

Answer 34

By partially differentiating the supply/demand function with respect to the changing variable.

Question 35

What is an implication of the fact that, in the textbook example, the total supply curve is the horizontal sum of the domestic and foreign supply curves?

Answer 35

The total supply curve is flatter than either of the two supply curves.

Question 36

How do we mathematically solve for market equilibrium?

Answer 36

By using the demand and supply functions to solve for the equilibrium price at which Qs = Qd. Then, we substitute peq in either equation to find Qeq.

Question 37

What causes the market to be in equilibrium?

Answer 37

If the price were not at the equilibrium level, consumers and firms would have an incentive to change their behavior in a way that would drive the price to the equilibrium level.

Question 38

What is excess demand?

Answer 38

The amount by which the quantity demanded exceeds the quantity supplied at a specified price.

Question 39

What is excess supply?

Answer 39

The amount by which the quantity supplied exceeds the quantity demanded at a specified price.

Question 40

When would an equilibrium change?

Answer 40

If a shock occurs so that one of the variables we were holding constant changes, causing a shift in either the demand or supply curves.

Question 41

What is comparative statics?

Answer 41

The method used by economists to analyze how variables controlled by consumers and firms (p and Q) react to a change in exogenous variables (environmental variables) that they do not control.

Question 42

What are 4 exogenous variables considered in this chapter?

Answer 42

• Prices of substitutes
• Prices of complements
• Consumer income level
• Prices of production inputs

Question 43

How can we determine the comparative statics properties of an equilibrium by examining the effects of a discrete (relatively large) change in one environmental variable?

Answer 43

By solving for the before-and-after equilibria and comparing them using mathematics or a graph.

Question 44

How can we determine the comparative statics properties of an equilibrium by examining the effects of a small change in one environmental variable?

Answer 44

By using calculus to determine the effect of a small change in one environmental variable, holding the other such variables constant.

Question 45

Show how the calculus works when an exogenous variable a (which affects input prices) changes. Continue from:
Q = D(p) ; Q = S(p,a)
Equate them to make
D(p) = S(p,a)

Answer 45

This is an identity: as a changes, p changes so that the equation continues to hold. Thus, we write equilibrium price as an implicit function of the environmental variable:
p = p(a) Therefore:
D(p(a)) = S(p(a),a)
Then differentiate this equation with respect to a using the chain rule.

Question 46

What is the derivative of
D(p(a)) = S(p(a),a)
using the chain rule?

Answer 46

dD(p(a))/dp X dp/da

(‘dS(p(a),a)/’dp)(dp/da) + ‘dS(p(a),a)/’da

Question 47

Why do the shapes of demand and supply curves matter?

Answer 47

Because the shapes and positions of the demand and supply curves determine by how much a shock affects the equilibrium price and quantity.

Question 48

How would a supply shock affect a vertical demand curve differently than a downward sloping one?

Answer 48

P rises/falls by more when the demand curve is vertical instead of downward sloping, but q remains the same.

Question 49

How would a supply shock affect a what consumers pay differently if they have a horizontal demand curve as opposed to a downward sloping one?

Answer 49

Q rises/falls by more than when the demand curve is vertical or downward sloping, but p remains the same.

Question 50

What is an elasticity?

Answer 50

The percentage change in one variable in response to a given percentage change in another variable, holding other relevant variables constant.

Question 51

What is the formula for an elasticity E?

Answer 51

E = (%Δz)/(%Δx) = (Δz/z)/(Δx/x) = (‘dz/’dx)(x/z)

Question 52

What is the price elasticity of demand, or simply the demand elasticity or elasticity of demand?

Answer 52

The percentage change in the quantity demanded, Qd, in response to a given percentage change in the price, p, at a particular point on the demand curve.

Question 53

What is the formula for the price elasticity of demand?

Answer 53

ε = (%ΔQ)/(%Δp) = (ΔQ/Q)/(Δp/p) = (‘dQ/’dp)(p/Q)
Where ‘dQ/’dp is the partial derivative of the demand function with respect to p, that is, holding constant other variables that affect the quantity demanded.

Question 54

Describe a linear demand function where Qd = a - bp.

Answer 54

For a linear demand function Qd = a - bp, a is the quantity demanded when the price is zero and b is the ratio of the fall in the quantity relative to the rise in price: the derivative dQ/dp.

Question 55

What is the ε for a linear demand function Qd = a - bp where a is the quantity demanded when the price is zero and b is the ratio of the fall in the quantity relative to the rise in price: the derivative dQ/dp?

Answer 55

ε = (dQ/dp)(p/Q) = -b(p/Q)

Question 56

What does the negative sign on the formula for elasticity of demand ε = -b(p/Q) illustrate?

Answer 56

The law of demand: Less quantity is demanded as the price rises.

Question 57

Which question does the elasticity of demand concisely answer?

Answer 57

How much does the quantity demanded of a product fall in response to a 1% increase in its price?
A 1% increase in price leads to an ε% change in the quantity demanded.

Question 58

The elasticity of demand varies along most demand curves. How is it distributed then?

Answer 58

On downward sloping linear demand curves that are neither vertical nor horizontal, the higher the price, the more negative the elasticity of demand.

Question 59

What is ε where a linear demand curve hits the quantity axis (p=0 and Q=a)?

Answer 59

ε = -b(0/a) = 0

Question 60

When is a demand curve said to be perfectly inelastic?

Answer 60

A demand curve said to be perfectly inelastic at a point where the elasticity of demand is zero.

Question 61

What is a physical analogy to perfect inelasticity?

Answer 61

If you try to stretch an inelastic steel rod, the length does not change. The change in the price is the force pulling at demand; if the quantity demanded does not change in response to this force, the demand curve is perfectly inelastic.

Question 62

What is ε for quantities between the midpoint of the linear demand curve and the lower end, where Q=a?

Answer 62

0 > ε > -1

A point along the demand curve where the elasticity is between 0 and -1 is inelastic (but not perfectly inelastic)

Question 63

What is ε for quantities at the midpoint of the linear demand curve, where p = a/(2b) and Q = a/2?

Answer 63

ε = -bp/Q = -b[a/(2b)]/(a/2) = -1.

Such an elasticity of demand is called a unitary elasticity.

Question 64

What is ε for prices above the midpoint of the linear demand curve?

Answer 64

At prices higher than at the midpoint of the demand curve, the elasticity of demand is less than negative one, ε < -1.
In this range, the demand curve is called elastic.

Question 65

What happens to ε as price rises?

Answer 65

As the price rises, the elasticity gets more and more negative, approaching negative infinity. Where the demand curve hits the price axis, it is perfectly elastic.

Question 66

The elasticity of demand varies along most demand curves, not just downward sloping ones. What’s an exception to this?

Answer 66

Along a special type of demand curve, called a constant-elasticity demand curve, the elasticity is the same at every point along the curve.

Question 67

What is the exponential form characteristic to all constant-elasticity demand curves?

Answer 67

Qd = Ap^ε

where A is a positive constant and ε, a negative constant, is the elasticity at every point along this demand curve.

Question 68

How can we rewrite the equation Qd = Ap^ε

Answer 68

By taking natural logarithms of both sides, we can rewrite this exponential demand curve as a log-linear demand curve
lnQ = lnA + εlnp

Question 69

There are many different constant-elasticity demand curves with different elasticities. How can we characterize them graphically?

Answer 69

Except for the vertical and horizontal demand curves, the curves are convex to the origin (like indifference curves).

Question 70

What is the elasticity at any point along a horizontal demand curve?

Answer 70

Infinity

Question 71

Along the horizontal demand curve, people are willing to buy as much as firms sell at any price less than or equal to p*. How does this relate to its elasticity?

Answer 71

If the price increases even slightly above p*, however, demand falls to 0. Thus, a small increase in price causes an infinite drop in the quantity demanded, which means that the demand curve is perfectly elastic.

Question 72

What’s one reason why a demand curve would be horizontal?

Answer 72

One reason is that consumers view one good as identical to another good and do not care which one they buy.

Question 73

What is the elasticity at any point along a vertical demand curve?

Answer 73

The vertical demand curve is perfectly inelastic everywhere so ε=0. As the price goes up, the quantity demanded is unchanged dQ/dP = 0 so the elasticity of demand must be 0:
ε = (dQ/dP)(p/Q) = 0 x (p/Q) = 0

Question 74

What’s one reason why a demand curve would be vertical?

Answer 74

A demand curve is vertical for essential goods - goods that people feel they must have and will pay anything to get.

Question 75

We refer to the price elasticity of demand as the elasticity of demand, but what are 2 other elasticities of demand?

Answer 75

Income elasticity of demand

Cross-price elasticity of demand

Question 76

What is the income elasticity of demand?

Answer 76

A measure of how sensitive the quantity demanded at a given price is to income, which is a percentage change in the quantity demanded in response to a given percentage change in income Y.

Question 77

What is the formula for income elasticity of demand?

Answer 77

ξ = (%ΔQ)/(%ΔY) = (ΔQ/Q)/(ΔY/Y) = (‘dQ/’dY)((Y/Q)

Where ξ is the greek letter xi.

Question 78

When is income elasticity of demand negative, zero, or positive?

Answer 78

If the Qd increases as income rises, ξ>0.
If the Qd is unaffected as income rises, ξ=0.
If the Qd decreases as income rises, ξ<0.

Question 79

What does a positive income elasticity mean?

Answer 79

That an increase in income causes the demand curve to shift to the right.

Question 80

How do income elasticities play an important role in our analysis of consumer behavior in chapter 5?

Answer 80

Typically, goods that consumers view as necessities, such as food, have income elasticities near zero. Goods that they consider luxuries generally have income elasticities greater than one.

Question 81

What is cross-price elasticity?

Answer 81

The percentage change in the quantity demanded in response to a given percentage change in the price of another good.

Question 82

What’s the expression for the cross-price elasticity of demand?

Answer 82

cross-price elasticity = (%ΔQ1)/(%Δp2) = (ΔQ1/Q1)/(Δp2/p2) = (‘dQ1/’dp2)((p2/Q1)

Question 83

When is the cross price elasticity negative?

Answer 83

For complements. If the cross-price elasticity is negative, people buy less of one good when the price of the other, second good increases: The demand curve for the first good shifts to the left.

Question 84

When is the cross price elasticity positive?

Answer 84

For substitutes. As the price of the second good increases, people buy more of the first good.

Question 85

What is the price elasticity of supply, or simply the supply elasticity or elasticity of supply?

Answer 85

The percentage change in the quantity supplied, Qs, in response to a given percentage change in the price, p, at a particular point on the supply curve.

Question 86

What is the expression for the price elasticity of supply?

Answer 86

η = (%ΔQ)/(%Δp) = (ΔQ/Q)/(Δp/p) = (‘dQ/’dp)(p/Q)

where Q is the quantity supplied. If n=2, a 1% increase in price leads to a 2% increase in the quantity supplied.

Question 87

When is η>0?

Answer 87

When the supply curve is upward sloping, (‘dp/’dQ)>0, so η>0.

Question 88

When is η<0?

Answer 88

When the supply curve is downward sloping, (‘dp/’dQ)<0, so η<0.

Question 89

What do we call a point on a supply curve where the elasticity of supply is η=0?

Answer 89

Perfectly inelastic. The supply does not change as the price rises.

Question 90

When is a supply curve inelastic?

Answer 90

If 0

Question 91

When is a supply curve elastic?

Answer 91

If η>1, the supply is elastic.

Question 92

When is a supply curve infinitely elastic?

Answer 92

If η=∞

Question 93

For which curves does supply elasticity not vary?

Answer 93

The supply elasticity does not vary along constant-elasticity supply functions, which are exponential or (equivalently) log-linear:
Q=Bp^η or
lnB + ηlnp.

Question 94

What does it mean for η to be a positive, finite number for a constant-elasticity supply function?

Answer 94

It starts at the origin.

Question 95

What kind of supply curve is perfectly inelastic?

Answer 95

A vertical one. No matter what the price, the firm supplies Q.

Question 96

What’s an example of a good with a inelastic supply?

Answer 96

Perishable items such as already-picked fresh fruit. If it isn’t sold, it quickly becomes worthless.

Question 97

What kind of supply curve is perfectly elastic?

Answer 97

A horizontal one. Firms supply as much as the market wants - a potentially unlimited amount - if the price is p* or above. Firms supply nothing at a price below p*, which does not cover their cost of production.

Question 98

What are two factors that determine whether short-run demand elasticities are larger or smaller than long-run elasticities?

Answer 98

The ease of substitution and storage opportunities. Often we can substitute products in the long=run but not in the short-run

Question 99

How may short-run supply curve elasticies differ from short-run supply curve elasticies?

Answer 99

If a manufacturing firm wants to increase production in the short run, it an do so by hiring workers to use its machines around the clock. However, how much it can expand its output is limited by the fixed size of its manufacturing plant and the number of machines it has.. In the long run, however, the firm can build another plant and buy or build more equipment. Thus, we would expect a firm’s long-run supply elasticity to be greater than it is in the short-run.

Question 100

What does how much a tax affects the equilbrium price and quantity and how much of the tax falls on consumers depend on?

Answer 100

The elasticities of demand and supply. Knowing only the elasticities of demand and supply, we can make accurate predictions about the effects of a new tax and determine how much of the tax falls on consumers.

Question 101

What are the two types of sales taxes that governments use?

Answer 101

The most common is called an ad valorem tax by economists and the sales tax by real people.
The other is a specific tax or unit tax.

Question 102

What is an ad valorem tax?

Answer 102

For every dollar that a consumer spends, the government keeps a fraction, α, which is the ad valorem tax rate.

Question 103

What is a specific tax?

Answer 103

A tax where a specified dollar amount, t, is collected per unit of output.

Question 104

How does a specific tax collected entirely from firms affect the demand and supply graphically?

Answer 104

The after-tax supply curve is τ above the originial supply curve at every quantity.

Question 105

Which formula allows us to see the incidence of a tax on consumers?

Answer 105

dp/dτ = η/(η-ε)

Question 106

Which formula allows us to see the incidence of a tax on producers?

Answer 106

1 - dp/dτ = 1 - η/(η-ε)

Question 107

What does the equation dp/dτ = η/(η-ε) show?

Answer 107

For a given η, the more elastic the demand, the less the equilibrium price rises when a tax is imposed. Similarly, for a given ε, the smaller the supply elasticity, the smaller the increase int he equilibrium price that consumers pay when a tax is imposed.

Question 108

What is a special feature of specific taxes?

Answer 108

A specific tax, regardless of whether the tax is collected from consumers or producers, creates a wedge equal to the pre-unit tax of τ between the price consumers pay, p, and the price producers receive, p-τ. In short, regardless of whether firms or consumers pay the tax to the government, you can solve tax problems by shifting the supply curve, shifting the demand curve, or inserting a wedge between the supply and demand curves. All three approached give the same answer.

Question 109

Suppose the government imposes an ad valorem tax of α, instead of a specific tax, on the price that consumers pay for processed pork. We already know that the equilibrium price is $4 with a specific tax of 1.05 per kg. Which ad valorem tax collect an amount equal to a specific tax of 1.05/kg?

Answer 109

α = $1.05/$4 = 26.25% raises the same amount of tax per unit as a $1.05 specific tax.
The incidence of an ad valorem tax is usually shared between producers and consumers.

Question 110

When may Qs not equal Qd?

Answer 110

With a binding price ceiling or binding price floor.

Question 111

What is a price ceiling?

Answer 111

A price ceiling limits the amount that can be charged for a product.

Question 112

How does the price ceilings affect market outcomes?

Answer 112

The ceiling doesn’t affect market outcomes if it is set above the equilibrium price that would be charged in the absence of the price control.

Question 113

What do binding price ceilings cause?

Answer 113

Shortages.

Question 114

What do binding price floors cause?

Answer 114

Surpluses

Question 115

What is on of the most important examples of a price floor?

Answer 115

The minimum wage in labor markets.

Question 116

How do minimum wages affect market outcomes?

Answer 116

If the minimum wage binds - exceeds the equilibrium wage, w* - the minimum wage causes unemployment, which is a persistent excess supply of labor.

Question 117

How does minimum wage lead to unemployment?

Answer 117

The minimum wage prevents market forces from eliminating the excess supply, so it leads to an equilibrium with unemployment.

Question 118

What is a perfectly competitive market?

Answer 118

One in which all firms and consumers are price takers: No market participants can affect the market price.

Question 119

What are the 5 characteristics of perfectly competitive markets?

Answer 119

1. There are many small buyers and sellers
2. All firms produce identical products
3. All market participants have full information about prices and product characteristics.
4. Transaction costs are negligible.
5. Firms can easily enter and exit the market.

Question 120

In which markets are firms price setters?

Answer 120

Monopolies and Oligopolies.

Question 121

What is a monopoly?

Answer 121

A price setter which benefits from being the only supplier in a market.

Question 122

What is an oligopoly?

Answer 122

A market with only a small number of firms - or in a markets in which they sell differentiated products, and consumers prefer one product to another.

Question 123

How is the market price in monopolies and oligopolies relative to perfect competition?

Answer 123

Generally higher.

Question 124

What are transaction costs?

Answer 124

The expenses, over and above the price of the product, of finding a trading partner and making a trade for the product. These costs include the time and money spent gathering information about a product’s quality and finding someone with whom to trade.

Question 125

In which markets is the supply and demand model useful?

Answer 125

Markets in which the supply-and-demand model has proven useful - markets with many firms and consumers and in which firms sell identical products - include agriculture, finance, labor, construction, services, wholesale, and retail.