Chapter 2: The Basics Of Supply And Demand

Question 1

One of the best ways to understand relevance of economics is by using

Answer 1

Demand and supply analysis

Question 2

The demand and supply analysis is a tool that can be applied to a variety of problems such as

Answer 2

• understanding and predicting changes in world economic conditions
• evaluating impact of government price controls, minimum wages, price supports etc.
• determine how taxes, subsidies, tariffs, import quotas affect the market

Question 3

What does the demand curve illustrate

Answer 3

It shows how much of a good consumers are willing to buy as the price per unit changes. It is the relationship between the quantitative demanded and the price. Customers buy more if the price is lower, it is an inverse relationship

Question 4

What does the supply curve illustrate

Answer 4

It shows the quantity/relationship of a good that producers are willing to sell at a given price, holding constant any other factors (ceteris paribus)

Question 5

Higher prices lead to

Answer 5

Higher output and production and lower demand

Question 6

Other factors that affect supply besides prices are

Answer 6

• production costs
• future expected prices
• productivity

Question 7

*Change in supply refers to ___, while change in the quantity supplied refers to ___

Answer 7

Change in the supply refers to shifts in the supply curve while change in the quantity supplied refers to movements along the supply curve

Question 8

If consumers buy more when the price is low, what type of relationship is there between price and demand:

A) positive relationship
B) inverse relationship
C) negative relationship

Answer 8

B) inverse relationship

Question 9

Other factors that affect demand besides prices are

Answer 9

• income
• taste
• prices of other goods

Question 10

Change in demand refers to ___, while change in the quantity demanded refers to ___

Answer 10

Change in demand refers to shifts in the demand curve while change in the quantity demanded refers to movements along the demand curve due to price

Question 11

What are substitute goods

Answer 11

Two goods for which an increase in the price of one leads to an increase in the quantity demanded of the other (positive relationship)

Question 12

What are complimentary goods

Answer 12

Two goods for which an increase in the price of one leads to a decrease in the quantity demanded of the other (negative relationship).

Question 13

What is market mechanism

Answer 13

It is the tendency in a flea market for price to change until the market clears (reaches equilibrium). At this point there is neither access demand or supply

Question 14

Differentiate between surplus and shortage

Answer 14

Surplus is a situation in which the quantity supplied exceeds the quantity demanded. (any price above equilibrium creates a surplus)

Shortage is a situation in which the quantity demanded exceeds the quantity supplied. (any price below equilibrium creates a shortage)

Question 15

Changes in equilibrium occur based on what three scenarios/changes

Answer 15

1. Only a shift in supply
2. Only a shift in demand
3. A simultaneous change in both supply and demand

Question 16

Define elasticity

Answer 16

Elasticity measures the sensitivity of one variable to another. Generally elasticity depends on the availability of substitutes, when more substitutes are available the higher the elasticity of demand (sensitive).

• When Ep >1 demand is price elastic (sensitive)
• When Ep <1 demand is price inelastic (not sensitive)

Question 17

What are the different types of elasticities

Answer 17

1. Price elasticity of demand
2. Income elasticity of demand
3. Cross price elasticity of demand
4. Price elasticity of supply

Question 18

Explain price elasticity of demand

Answer 18

It is the percentage change in quantity that is demanded of a good, due to a 1% increase in its price. It will always be negative given the inverse relationship between price and quantity demanded.

Question 19

The demand curve is illustrated by ___

Answer 19

A linear line expressed as Q=a-bP

Question 20

What is an infinitely elastic demand

Answer 20

Consumers buy as much of a good as they can get a single price, but for any higher price the quantity demanded drop to 0, while for any lower price the quantity demanded increases without limit

Question 21

What is a completely inelastic demand

Answer 21

Consumers will buy a fixed quantity of good regardless of its price

Question 22

Explain income elasticity of demand

Answer 22

It is the percentage change in quantity that is demanded of a good, due to a 1% increase in income

Question 23

Explain cross price elasticity of demand

Answer 23

It is the percentage change in quantity that is demanded of a good, due to a 1% increase in the price of another good (substitute or complimentary)

If Ec is positive (>0) = substitute and if Ec is negative (<0) = complements

Question 24

Explain price elasticity of supply

Answer 24

It is the percentage change in quantity that is supplied of a good, due to a 1% increase in price (will always be positive, as high price induce higher supply)

Question 25

Differentiate between point and arc elasticities

Answer 25

Point elasticity measures elasticity at a particular point. Arc elasticity is calculated over a range of prices.

Question 26

*In demand elasticity what’s the difference between the short run and long run

Answer 26

Durable goods are much more price elastic (sensitive) in the short run as products have a longer lifespan. For example cars, fridges.

Non-durable goods are much more price elastic in the long run as lifespan of the products are short. For example coffee, petrol.

The difference between the short and the long run is largely dependent on durability

Question 27

In the elasticity of supply what’s the difference between the short run and the long run

Answer 27

For most goods supply is more elastic in the long run. Due to firms capacity constraints they are unable to expand production significantly in the short run

Question 28

Besides taxation and subsidies, government conducts ___

Answer 28

Market regulation. One of these interventions being price controls or minimum and maximum price fixing. (maximum price fixing creates access demand -shortage- and minimum price fixing creates excess supply -surplus-)