Chapter 2 Flashcards
What is the Law of Demand?
The Law of Demand simply proposes that as the price of a good falls, the quantity you would be willing and able to purchase increases, given that everything else remains unchanged (“ceteris paribus”).
What is the demand curve?
The demand curve represents the quantities of a good or service that consumers are willing and able to purchase at various prices
What does the law of demand imply with respect to a demand curve?
Downward
Negative
Inverse relationship
What is an extension of demand?
A movement down the demand line
A price decrease and a quantity demand increase
What is a contraction of demand
A movement up the demand line to the left
A price increase and a quantity demand decrease
Why must you be careful with contraction and extension of demand?
They relate to movements along the demand curve NOT movements of the demand curve itself which is known as a shift in demand
What are the five “conditions of demand”
-Changing price of a substitute
-Changing price of a complement
-Change in the income of consumers
-Change in tastes and preferences
-Changes in interest rates
What does a ‘condition of demand’ do?
they would lead to changes in demand at all price levels (i.e. a movement of the entire demand curve either outwards (increase) or inwards (decrease)
Explain ‘Changing price of a substitute’
Substitutes are goods in competitive demand and act as replacements for another product. Consumers will tend to switch to the cheaper brand or service provider.
For example, Oranges are substitutes for Apples.
Explain ‘Changing price of a complement’
A complement tends to be bought together with another good. Two complements are said to be in joint demand.
Examples include: fish and chips, DVD players and DVDs,
A rise in the price of a complement to Good X will cause a fall in the demand for Good X.
For example, a decrease in the cost of flights from London Heathrow to New York would cause an increase in the demand for hotel rooms in New York and also an increase in the demand for taxi services both
in London and New York.
Explain ‘Change in the income of consumers’
Most of the things we buy are normal goods, that is, more is bought when income rises. When an individual’s income goes up, their ability to purchase goods and services increases, and this causes an outward shift in the demand curve. When incomes fall, there will be a decrease in the
demand for most goods (see note on inferior goods below)
Explain ‘Change in tastes and preferences’
Tastes can often be volatile leading to a change in demand. An example would be demand for British beef during the BSE crisis. Advertising is designed to changes the tastes and preferences
of consumers and thereby causes a change in demand.
Explain ‘Change in interest rates’
Many goods are bought on credit using borrowed money
intrest rates up demand shift down
What is an Inferior good?
inferior goods for which an increase
in income leads to a decrease in demand.
e.g. cheap ice cream vs premium ice cream
What is a normal good?
an increase in income leads to an increase in demand (the demand curve shifts to the right)
What is an inferior good?
an increase in income leads to a decrease in demand (the demand curve shifts to the left)
What is ‘Supply?
Supply is the quantity of a good or service that a producer is willing and able to supply onto the market at a given price in a given time period.
What does a supply curve show?
The supply curve shows a relationship between the price of a good or service and the quantity a producer is willing and able to sell in the market.
What are the 6 conditions of supply
-Costs of production
-Changes in production technology
-Government taxes and subsidies
-Climatic conditions
-Change in the price of a substitute
-The number of producers in the market
Explain ‘Changes in production technology’
Technology can change very quickly and in industries where the pace of technological change is rapid we expect to see increases in supply (and therefore lower prices for the consumer)
Explain ‘Government taxes and subsidies’
Government intervention in a market can have a major effect on supply. A tax on producers causes an increase in costs and will cause the supply curve to shift upwards. Less will be supplied after the tax is introduced.
A subsidy has the opposite effect as a tax cut. A subsidy will increase supply because a guaranteed payment from the Government reduces a firm’s costs allowing them to produce more output at a given price. The supply curve shifts downwards and to the right depending on
the size of the subsidy
Explain ‘Climatic conditions’
For agricultural commodities such as coffee, fruit and wheat the climate can exert a great influence on supply. Favourable weather will produce a bumper harvest and will increase supply. Unfavourable weather conditions such as a drought will lead to a poor harvest and decrease supply. These unpredictable changes in climate can have a dramatic effect on market
prices for many agricultural goods
Explain ‘Change in the price of a substitute’
A substitute in production is a product that could have been produced using the same resources. Increase in price sub, decrease in demand
Explain ‘The number of producers in the market’
The number of sellers in a market will affect total market supply. When new firms enter a market, supply increases and causes downward pressure on the market price.
What is price equilibrium?
Price equilibrium is found where supply and demand are equal. This is the point where both sellers and buyers are happy with the price and quantity.
market clearing price
With a supply curve, what happens when the price changes
If the price of the good reduces (ceteris paribus) there will be a movement down the supply curve (contraction) and if the price of the good increases
there will be a movement up the supply curve (extension).
what are the three main reasons for a positive supply relationship?
1) Profitability)p rises more profitable for businesses to increase their output.
2)Costs) Higher prices send signals to firms that they can increase their profits by satisfying demand in the market.
3) Competition) Higher prices make it more profitable for other firms to start producing that product so we may see new firms entering the market leading to an increase in supply
What causes contraction or extension of supply?
Price increase (extension)
Price decrease (contraction
towards q=0 contraction
What is a condition of supply?
changes in factors other than price that cause a shift in the supply curve itself
-a move to the right = increase in supply = outwards RIO :)
-a move to the left = decrease in supply = inwards LDI :(
What is a consumer surplus?
can you draw a graph?
Surplus of consumers who were prepared to pay more than the equilibrium price?
What is a producer surplus
cann you draw graph?
Surplus of producers who were prepared to supply at less than the equilibrium price
What is excess supply? How is equilibrium reached?
Price above eqm
excess supply is the difference
What is excess demand?
Price below eqm point
excess demand is the difference
What is the market clearing price?
price at eqm point /eqm price
What is the market clearing price?
price at eqm point /eqm price
What does ceteris paribus mean
that everything else stays the same
Short version: law of demand
price falls, quantity rises
Short version: law of supply
price rises, quantity rises
