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COMM220 > Chapter 2 - The basics of Supply and Demand > Flashcards

Chapter 2 - The basics of Supply and Demand Flashcards

1
Q

What is the demand curve?

A

Shows the relationship between the quantity of a good that consumers are willing to buy (willingness to buy) and the price of the good. We can write this relationship between quantity demanded and price as an equation:

QD = QD(P)

(where QD is quantity demanded, and P is the price of the good.)

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2
Q

True or False:

For a demand curve, Y axis is the price, and X axis is the quantity demanded.

A

True

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3
Q

True or False:
Usually, the demand curve is downward sloped (slope of the demand curve is
smaller than 0).

A

True

The law of demand states that there is a negative, or inverse, relationship between price and the quantity of a good demanded and its price. The higher the price, the less quantity demanded by consumers.

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4
Q

What is movement along the demand curve?

A

A movement along the demand curve for a good is caused and only can be caused by the changes in the price of that good.

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5
Q

What are shifts in the demand curve?

A

Shifts in the demand curve of a good is caused by factors than the price of that good that may have impact on the demand of a good.

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6
Q

What are factors that may shift the demand curve?

A

Changes in income, preferences, or prices of other goods or services.

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7
Q

What can create changes in income that may shift the demand curve?

A

Inferior goods vs normal goods

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8
Q

What are inferior goods?

A

Goods for which demand falls when income rises.

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9
Q

What are normal goods?

A

Goods for which demand goes up when income is higher and for which demand goes down when income is lower.

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10
Q

How does consumers preferences potentially shift the demand curve?

A

Ex: Mike does not like soda as much as before because he is more health conscious. How is Mike’s demand for soda drinks going to change as a result?

He is going to be less inclined to buy soda now. Demand will decrease.

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11
Q

What can create changes in prices of other goods that may shift the demand curve?

A

Substitutes and Complements

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12
Q

What are substitute goods?

A

Goods that can serve as replacements for one another; when the price of one increases, demand for the other goes up. Perfect substitutes are identical products.

Ex: aluminum and copper are substitute goods in industrial use. If the
price of aluminum goes up, then the demand for copper will shift right (increase).

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13
Q

What are complement goods?

A

Goods that “go together”; a decrease
in the price of one results in an increase in demand for the other, and
vice versa.

Ex: computers and computer software are complementary goods. The
price of computer decreases will result in an increase (shifts right) in the demand for
computer software packages.

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14
Q

What is market demand vs household demand (demand of a single consumer)?

A

Market demand is the sum of all the quantities of a good or service demanded per period by all the households buying in the market for that good or service.

Ex: Household A + Household B + … = Market Demand

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15
Q

What is the supply curve?

A

Shows the relationship between the quantity of a good that producers are willing to sell and the price of the good. We can write this relationship as an equation:

QS = QS(P)

(where QS is the quantity supplied by producer, and P is the price of the good.)

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16
Q

True or False:
The supply curve is usually sloped upward (the slope of the supply curve is greater than 0).

The higher the price, the more that firms are able and willing to produce and sell.

A

True

The law of supply states that there is a positive relationship between price and quantity of a good supplied.

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17
Q

What is movement along the supply curve?

A

A movement along the supply curve for a good is caused and only can be caused by the changes in the price of that good.

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18
Q

What is change/shifts in supply curve?

A

Factors other than the price of that good may shift the supply curve of the interested good.

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19
Q

What are factors that may shift the supply curve?

A

Changes in production costs, input prices, technology, or prices of related goods and services.

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20
Q

True or False:
An increase in the cost of production, input prices will shift the supply curve
to the left (or a decrease in supply);

A

True

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21
Q

True or False:
An improvement of technology reduces the production cost of goods will shift the supply curve to the right (or an increase in supply).

A

True

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22
Q

What are the characteristics of market supply and firm supply curve?

A
  • Every firm has their own supply curve
  • Market supply curve is the horizontal summation of individual firms’ supply curves

Firm A + Firm B + … = Market Supply

23
Q

What is the market mechanism?

A

Tendency in a free market for price to change until the market clears.

24
Q

What does the operation of the market depend on?

A

The interaction between buyers and sellers.

25
Q

What is market equilibrium?

A

The condition that exists when quantity supplied and quantity demanded are equal. At equilibrium, there is no tendency for the market price to change.

26
Q

What is equilibrium price (market-clearing price)?

A

The price that equates the quantity supplied to the quantity demanded.

27
Q

What is surplus?

A

Situation in which the quantity supplied exceeds the quantity demanded;

28
Q

What is shortage?

A

Situation in which the quantity demanded exceeds the quantity supplied.

29
Q

What does lower demand lead to?

A

Lower price and lower quantity exchanged.

30
Q

What does lower supply lead to?

A

Higher price and lower quantity exchanged.

31
Q

What does higher demand lead to?

A

Higher equilibrium price and higher equilibrium quantity.

32
Q

What does higher supply lead to?

A

Lower equilibrium price and higher equilibrium quantity.

33
Q

What is the relative magnitudes of change in supply and demand?

A
  • Determine the outcome of market equilibrium.

- When supply and demand both increase, quantity will increase, but price may go up or down.

34
Q

What is elasticity?

A

Percentage change in one variable resulting from a 1-percent change in another.

35
Q

What is price elasticity of demand?

A

Estimates the percentage change in quantity demanded of a good resulting
from a 1-percent change in its price. Using ED to denote the price elasticity of demand, it can be expressed in the following function:

ED = %∆Q/%∆P = (∆Q/Q)/(∆P/P) = ∆Q/∆P * P/Q

The price elasticity of demand is usually a negative number. When the price of a good increases, the quantity demanded usually falls.

When demand function is a linear function of P, the price elasticity of demand decreases as quantity demanded increases.

36
Q

What happens if ED > 1 in magnitude?

A

The demand is price elastic, a 1% change in price leads to a greater than 1% change in quantity demanded.

37
Q

What happens if ED = 1 in magnitude?

A

The demand is unit elastic, a 1% change in price leads to 1% change in quantity demanded.

38
Q

What happens if ED < 1 in magnitude?

A

The demand is price inelastic, a 1% change in price leads to a smaller than 1% change in quantity demanded.

39
Q

What are factors that can affect price elasticities of demand?

A
  1. Number of substitutes;
  2. Luxury goods and Necessity goods;
  3. Price of the goods relative to income;
  4. The time period under consideration.
40
Q

What are the two special cases of Elastic and Inelastic demand?

A
  • Infinitely Elastic Demand (price remains fixed/constant across the quantity)
  • Completely Inelastic Demand (quantity remains fixed/ across the price)
41
Q

What is the income elasticity of demand?

A

Percentage change in the quantity demanded resulting from a 1-percent change in income.

EI = %∆Q/%∆I = (∆Q/Q)/(∆I/I) = ∆Q/∆I * I/Q

42
Q

True or False:

The demand for Luxury goods are income elastic, but the demand for necessities are income inelastic.

A

True

43
Q

True or False:
The income elasticities for normal goods are greater than zero; the income elasticities for inferior goods are smaller than zero.

A

True

44
Q

What is cross-price elasticity of demand?

A

Percentage change in the quantity demanded of one good resulting from a 1-percent increase in the price of another.

EQbPm = %∆Qb/%∆Pm = (∆Qb/Qb)/(∆Pm/Pm) = ∆Qb/∆Pm * Pm/Qb

If goods are substitutes, the cross-price elasticities will be positive; if goods are complements, the cross-price elasticities will be negative.

45
Q

What is price elasticity of supply?

A

Percentage change in quantity supplied resulting from a 1-percent change in price. The price elasticity of supply is usually positive because a higher price gives producers an incentive to increase output.

ES = %∆Q/%∆P = (∆Q/Q)/(∆P/P) = ∆Q/∆P * P/Q

  1. The easier and more rapid the transfer of resources, the greater is the price elasticity of supply;
  2. The longer a firm has to adjust, normally the higher the price elasticity of supply.
46
Q

What is the point elasticity of demand?

A

Price elasticity at a particular point on the demand curve.

47
Q

What is arc elasticity of demand?

A

Price elasticity calculated over a range of prices.

ED = %∆Q/%∆P = (∆Q/Q̅)/(∆P/P̅) = ∆Q/∆P * P̅/Q̅

48
Q

At the market equilibrium: QD = ?, PD = ?

A

QD = QS, PD = PS

49
Q

What is the general form of demand and supply functions?

A

Demand function: QD = a − bP

Supply function: QS = c + dP

50
Q

What is the price elasticity of demand?

A

ED = %∆Q/%∆P = (∆Q/Q)/(∆P/P) = ∆Q/∆P * P/Q = -b * P/Q

51
Q

What is the price elasticity of supply?

A

ES = %∆Q/%∆P = (∆Q/Q)/(∆P/P) = ∆Q/∆P * P/Q = d * P/Q

52
Q

Suppose we know the price elasticity of supply and demand at the market equilibrium, ES* and ED, we also know the market clearing price P and market clearing quantity Q*, then… (where * symbol means equilibrium)

A 
b = −ED*(Q*/P*);
d = ES*(Q*/P*);

Knowing b, Q* and P, a can be solved; knowing d, Q and P*, c can be solved. Then the demand and supply functions are obtained.

53
Q

What can a price ceiling lead to?

A

A price ceiling may lead to curtailments and supply rationing, and consumers switch to other markets.

COMM220 (5 decks)

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