CH4: Changes in Demand & Supply Flashcards
What is the effect of an increase in demand on equilibrium price and quantity?
An increase in demand shifts the demand curve to the right, raising both the equilibrium price and the equilibrium quantity, ceteris paribus.
What causes the demand curve to shift to the right?
Factors include an increase in the price of substitute goods, higher consumer income, positive changes in consumer preferences, or expectations of future price increases.
What is the result of a decrease in demand?
A decrease in demand shifts the demand curve to the left, leading to a lower equilibrium price and quantity, ceteris paribus.
What is the effect of an increase in supply on equilibrium?
An increase in supply shifts the supply curve to the right, resulting in a lower equilibrium price and a higher equilibrium quantity.
Which factors can increase supply?
Falling prices of alternative or joint products, reduced input costs, improved productivity, and advancements in technology.
What is the effect of a decrease in supply?
A decrease in supply shifts the supply curve leftward, leading to a higher equilibrium price and a lower equilibrium quantity.
What factors cause a decrease in supply?
Rising costs of production, lower productivity, and increases in prices of alternative or joint products.
Define consumer surplus.
Consumer surplus is the difference between what consumers are willing to pay for a good and what they actually pay. It represents a gain to consumers.
Define producer surplus.
Producer surplus is the difference between the price producers receive for a good and the minimum price at which they are willing to supply it.
Where are consumer and producer surplus found in market equilibrium?
Consumer surplus is the area above the equilibrium price and below the demand curve. Producer surplus is the area below the equilibrium price and above the supply curve.
Simultaneous Changes in Demand and Supply
When both demand and supply change, predicting the outcome on price and quantity depends on the relative magnitude of shifts. For example, if demand increases and supply decreases, price will rise, but quantity may increase, decrease, or stay the same.
Interaction Between Related Markets
A change in one market can affect another. E.g., a cost increase in motorcar production reduces quantity, which lowers demand for tyres, decreasing their price and quantity.
Government Intervention
Occurs when government alters market-determined prices/quantities due to public dissatisfaction. Includes price ceilings/floors, subsidies, taxes, tariffs, and quotas.
Maximum Prices (Price Ceilings)
A price set below equilibrium to make goods affordable (e.g., bread). Leads to excess demand and shortages. Can cause waiting lists, rationing, and black markets.
Black Markets
Illicit trading outside government control, typically arising when goods are price-controlled or scarce. Consumers pay more to bypass shortages.
Welfare Costs of Maximum Price Fixing
Price ceilings lead to deadweight loss: part of consumer/producer surplus is lost due to reduced traded quantity. Results in societal inefficiency.
Minimum Prices (Price Floors)
Set above equilibrium to protect producers (e.g., farmers). Leads to surpluses. Government may store, export, destroy or restrict production to manage excess.
Deadweight Loss of Price Floors
Occurs when minimum price leads to underconsumption and overproduction. Some consumer and producer surplus is lost, reducing total welfare.
What is a better alternative to minimum price fixing to support producers?
Direct cash subsidies to struggling producers, avoiding interference in the price mechanism and ensuring transparency.
What is the total deadweight loss from minimum price fixing according to welfare analysis?
It is the sum of triangle B (lost consumer surplus) and triangle C (lost producer surplus).
What is the effect of a subsidy paid to producers on supply?
It shifts the supply curve to the right (downward), lowers the market price, increases quantity exchanged, and increases producers’ received price.
What is the difference between statutory and effective incidence of tax?
Statutory incidence is who pays the tax legally; effective incidence is who bears the actual burden of the tax.
Who shares the burden of an excise tax?
Consumers (pay more), producers/shareholders (receive less), and employees (possible lower wages or job losses).
What is deadweight loss in the context of taxation?
It is the loss of total surplus represented by the areas of triangle X and Y when tax distorts the market equilibrium.
Why do agricultural prices fluctuate more than manufactured goods?
Due to variable supply conditions influenced by weather, disease, perishability, and seasonal factors.
What paradox may occur when farmers increase production due to expected high prices?
Increased supply may lead to lower prices and reduced total income despite higher output.
