Chapter 3 Flashcards
What is ceteris paribus?
A basic hypothesis that the price of a product and the quantity demanded are negatively related, all other variables held constant. Furthermore, the price of a product and the quantity supplied are positively related.
Why? There are usually several products that satisfy any given want or desire. A reduction in the price of a product means the specific desire can now be satisfied more cheaply by buying more of that product. Furthermore, producers are interested in making profits. If the price of a particular product rises, then the production and sale of this product is more profitable.
What is Quantity Demanded?
A flow, as opposed to a stock.
The total amount that consumers desire to purchase in some time period is called the quantity demanded of a product.
Quantity bought (or exchanged) refers to actual purchases.
Other than price, what change will shift the demand curve to a new position?
- Consumer’s income
- Prices of other goods
- Consumer’s tastes
- Population
- Significant changes in weather
Differentiate between change in demand and change in quantity demanded.
- A change in demand refers to a shift of the entire curve.
- A change in quantity demanded refers to a movement along a given demand curve.
What is Quantity Supplied?
A flow, as opposed to a stock.
The amount of a product that firms desire to sell in some time period is called the quantity supplied of that product.
Quantity supplied is the amount that firms are willing to offer for sale and not necessarily the quantity actually sold.
Other than price, what will shift the supply curve to a new position?
- Prices of inputs
- Technology
- Taxes or subsidies
- Prices of other products
- Significant changes in weather
Differentiate between a change in supply and a change in quantity supplied.
- A change in supply is a shift of the entire supply curve
- A change in quantity supplied is a movement from one point on a curve to another point.
Describe the concept of a market. [3]
- A market may be defined as any situation in which buyers and sellers negotiate the transaction of some goods or services.
- Markets may differ in the degree of competition among various buyers and sellers.
- In a perfectly competitve market buyers and sellers are price takers.
What is equilibrium price?
At this price, every buyer finds a seller and every seller finds a buyer - the market ‘clears’.
Describe changes in market prices. [4]
- Four possible curve shifts:
- An increase in demand causes an increase in both the equilibrium price and equilibrium quantity.
- A decrease in demand causes a decrease in both the equilibrium price and equilibrium quantity.
- An increase in supply causes a decrease in the equilibrium price and an increase in the equilibrium quantity.
- A decrease in supply causes an increase in the equilibrium price and a decrease in the equilibrium quantity.
What conditions must be satisfied for price determination in a market to be well described by the demand-and-supply model? [3]
- Large number of consumers; each one small relative to the size of the market.
- Large number of producers; each one small relative to the size of the market.
- Producers must be selling ‘homogenous’ versions of the product.
Differentiate between the absolute price and the relative price.
- The absolute price of a product is the amount of money that must be spent to acquire one unit of that product.
- A relative price is the price of one good in terms of another.
- Demand and supply curves are drawn in terms of relative prices rather than absolute prices.
What is Qd?
Quantity demanded - a flow variable
Qd = quantity household1 wants2 to purchase given3 the own price, ceteris paribus4.
- Household = Demand side (buyer, consumer, purchaser)
- Wants = desire, willing, planned (not acutal amount purchased/exchanged)
- Dependent on own price (price of the actual good)
- Ceteris paribus = all other things equal
Differentiate between a flow variable and a stock variable.
Flow variable = over time
Stock variable = point in time
What is the reason for the inverse or negative relationship between price and quantity demanded? (i.e., as price decreases, the willingness to buy increases, ceteris paribus.)
- Buyer makes decision by comparing benefits and costs at the margin (marginal principle)
- Benefit = given; determined by buyer’s preferences
- Cost = opportunity cost = price, which can change
- Incentive - benefit (given) - opportunity costs changes.
- As the price increases, the net benefit decreases; thus, the buyer will be less willing to buy (incentive principle). (Like a decrease in consumer surplus).
Note: Scarcity, choice, and opportunity cost lie at the root of Supply, S and Demand, D. Incentive, Maximization and Marginal Principle apply to both!
What is the general shape of a demand curve?
Convex to the origin.
Describe the demand curve.
The relationship between the price and the quantity that the consumer is willing to purchase, ceteris paribus.
Qd = f (P ; ceteris paribus variables)
Demand = D = the function
Quantity demanded = Qd = a specific value on horizontal axis
Differentiate between a demand function and an inverse demand function.
Demand function (Qd = f (P), price on horizontal axis)
Inverse demand function (P = g (Qd), price on vertical axis)
- Causation can go either way
- a) Given price → determine quantity demanded
- b) Given quantity demanded → determine price
Define ceteris paribus variables and their effect on an individual’s demand curve. [4]
Ceteris paribus variables are variables that are held constant (is given) to determine the relationship between Price, P and Quantity Demanded Qd.
Describe complement goods with regard to a demand curve.
These are related goods in consumption used jointly. (e.g., ball and bat, chips and salsa, iPhone and case)
If the price of A goes up, the quantity demanded for its complement B goes down.
Describe substitute goods with regard to the demand curve.
These are related goods in consumption used alternatively. (e.g., Coca Cola and Pepsi Cola)
If the price of A goes up, then the quantity demanded for the substitute B goes up.
What causes movement along a demand curve?
Change in Price (independent variable) → ΔQd
What causes shift of a demand curve?
Changes in ceteris paribus variables → ΔD
Give the four steps to answer a question such as:
How does an increase in income affect demand?
-
Step 1: Is it a change in the OWN price?
- Yes: Shift along the curve and stop :)
- No: Go to step 2.
- In this case it must be a ceteris paribus variable
-
Step 2: What is the ceteris paribus variable? Is it costs?
- Yes: Go to Supply
- No: Go to Demand
- In this case, it’s income, which affects the Demand curve
-
Step 3: How does it affect the D curve, direct or inverse?
- Income affects the D curve directly because an increase in income increases the consumer’s willingness to purchase at any price.
-
Step 4: Which way does the curve shift?
- Increase: rightward shift
- Decrease: leftward shift
In this example, the D curve shifts RIGHT.
What is Qs?
Quantity supplied - a flow variable, Qs = quantity the firm1 wants2 to sell given3 the own price, ceteris paribus4.
- Firm = supply side (seller, store, factory)
- Desired = desire, willing, planned (not actual amount sold (Q exchanged)).
- Dependent on Own price (price of the actual good)
- ceteris paribus = all other things equal
What is the reason for the positive or direct relationship between Price, P and Quantity supplied, Qs? (i.e., as P decreases, the willingness to sell decreases ceteris paribus)
- Seller makes decision by comparing benefits and costs at the margin (marginal principle)
- Benefit = price, which can change.
- Cost = opportunity cost = alternative use of inputs, which is given
- Incentive = benefit (change) = opportunity cost (given)
- As the price increases, the net benefit increases, thus, seller more willing to sell. (incentive principle) (Like an increase in producer surplus)
Note: Scarcity, choice, and opportunity cost lie at the root of Supply, S and Demand, D. Incentive, Maximization and Marginal Principle apply to both!
Describe the supply curve.
The relationship between Price and Quantity that the producer is willing to produce, ceteris paribus.
Qs = f (P ; ceteris paribus variables)
Supply = S = the function
Quantity supplied = Qs = a specific value on horizontal axis
Define ceteris paribus variables and their effect on an individual’s supply curve. [4]
Variable that is held constant (is given) to determine the relationship between Price, P and Quantity supplied, Qs.
What causes movement along a supply curve?
Change in Price (independent variable) → ΔQs
What causes shift of a supply curve?
Change in ceteris paribus variables → ΔS
Describe complement goods with regard to the supply curve.
These are related goods in production produced jointly. (e.g., oil and gas)
If the price of A goes down, the quantity supplied for its complement B goes down.
Describe substitute goods with regard to the supply curve.
These are related goods in production produced alternatively. (e.g., wheat & oats)
An increase in the price of A causes a decrease in supply and a leftward shift of the supply curve for B.
A decrease in the price of A causes an increase in supply and a rightward shift of the supply curve for B.
Give the four steps to answer a question such as:
How does an increase in technology affect supply?
-
Step 1: Is it a change in price?
- No, so go to step 2.
-
Step 2: What is the ceteris paribus variable? Is it Costs?
- Yes! Technology, which affects costs, will affect the Supply curve.
-
Step 3: How does it affect the curve, direct or inverse?
- Costs affect the Supply curve inversely, because a decrease in costs increases the producer’s willingness to sell at any price.
-
Step 4: Which way does the curve shift?
- In this case, the curve shifts RIGHT.
Differentiate between desired Quantity, Q, actual Q, and equilibrium Q.
- desired Q of purchases by the consumer need not equal the desired levels of sales by the producer. ⇒ Qd and Qs
- actual Q purchased must equal the actually Q sold. ⇒ Qexchanged
- equilibrium Q: Equilibrium Price = Market Clearing Price = Both buyer and seller are satisfied. ⇒ Qe
What happens when there is excess supply, versus excess demand?
When Qs = Qd ⇒ equilibrium
What is the equilibrium principle?
If you are there, you will stay there.
Remains constant over time.
In the case of Demand, D and Supply, S.
IF D = S, THEN Pe and Qe.
What is the stability principle?
If you are not there, you will go there.
In the case of Demand, D and Supply, S.
IF Qs > Qd, THEN P falls to Pe
IF Qs < Qd, THEN P rises to Pe
D = S
Equilibrium.
Qd = Qs
Equilibrium price, market clearing price.
D ≠ S
Disequilibrium
Qd ≠ Qs
Disequilibrium price
Qd > Qs
Excess demand
Qd < Qs
Excess supply
Terminology
Equilibrium.
D = S
Terminology
Equilibrium price, market clearing price.
Qd = Qs
Terminology
Disequilibrium
D ≠ S
Terminology
Disequilibrium price
Qd ≠ Qs
Terminology
Excess demand
Qd > Qs
Terminology
Excess supply
Qd < Qs
What are the laws of Supply and Demand?
What is static analysis?
- Each graph is at a given point in time
- Shifts in curves superimpose different times on the same graph.
