Chapter 2

Question 1

What is the Law of Demand?

Answer 1

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”).

Question 2

What is the demand curve?

Answer 2

The demand curve represents the quantities of a good or service that consumers are willing and able to purchase at various prices

Question 3

What does the law of demand imply with respect to a demand curve?

Answer 3

Downward
Negative
Inverse relationship

Question 4

What is an extension of demand?

Answer 4

A movement down the demand line
A price decrease and a quantity demand increase

Question 5

What is a contraction of demand

Answer 5

A movement up the demand line to the left
A price increase and a quantity demand decrease

Question 6

Why must you be careful with contraction and extension of demand?

Answer 6

They relate to movements along the demand curve NOT movements of the demand curve itself which is known as a shift in demand

Question 7

What are the five “conditions of demand”

Answer 7

-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

Question 8

What does a ‘condition of demand’ do?

Answer 8

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)

Question 9

Explain ‘Changing price of a substitute’

Answer 9

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.

Question 10

Explain ‘Changing price of a complement’

Answer 10

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.

Question 11

Explain ‘Change in the income of consumers’

Answer 11

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)

Question 12

Explain ‘Change in tastes and preferences’

Answer 12

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.

Question 13

Explain ‘Change in interest rates’

Answer 13

Many goods are bought on credit using borrowed money
intrest rates up demand shift down

Question 14

What is an Inferior good?

Answer 14

inferior goods for which an increase
in income leads to a decrease in demand.

e.g. cheap ice cream vs premium ice cream

Question 15

What is a normal good?

Answer 15

an increase in income leads to an increase in demand (the demand curve shifts to the right)

Question 16

What is an inferior good?

Answer 16

an increase in income leads to a decrease in demand (the demand curve shifts to the left)

Question 17

What is ‘Supply?

Answer 17

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.

Question 18

What does a supply curve show?

Answer 18

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.

Question 19

What are the 6 conditions of supply

Answer 19

-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

Question 20

Explain ‘Changes in production technology’

Answer 20

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)

Question 21

Explain ‘Government taxes and subsidies’

Answer 21

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

Question 22

Explain ‘Climatic conditions’

Answer 22

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

Question 23

Explain ‘Change in the price of a substitute’

Answer 23

A substitute in production is a product that could have been produced using the same resources. Increase in price sub, decrease in demand

Question 24

Explain ‘The number of producers in the market’

Answer 24

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.

Question 25

What is price equilibrium?

Answer 25

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

Question 26

With a supply curve, what happens when the price changes

Answer 26

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).

Question 27

what are the three main reasons for a positive supply relationship?

Answer 27

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

Question 28

What causes contraction or extension of supply?

Answer 28

Price increase (extension)
Price decrease (contraction
towards q=0 contraction

Question 29

What is a condition of supply?

Answer 29

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 :(

Question 30

What is a consumer surplus?

Answer 30

can you draw a graph?
Surplus of consumers who were prepared to pay more than the equilibrium price?

Question 31

What is a producer surplus

Answer 31

cann you draw graph?
Surplus of producers who were prepared to supply at less than the equilibrium price

Question 32

What is excess supply? How is equilibrium reached?

Answer 32

Price above eqm
excess supply is the difference

Question 33

What is excess demand?

Answer 33

Price below eqm point

excess demand is the difference

Question 34

What is the market clearing price?

Answer 34

price at eqm point /eqm price

Question 35

What is the market clearing price?

Answer 35

price at eqm point /eqm price

Question 36

What does ceteris paribus mean

Answer 36

that everything else stays the same

Question 37

Short version: law of demand

Answer 37

price falls, quantity rises

Question 38

Short version: law of supply

Answer 38

price rises, quantity rises