Chapter 3 - Theory of Demand and Supply

Question 1

Define the market.

Answer 1

The market is defined as an arrangement whereby buyers and sellers, motivated by self-interest, interact to exchange goods and services.

Question 2

What is demand?

Answer 2

Demand is defined as the amount of goods that consumers are willing and able to buy at various prices over a given period of time, ceteris paribus.

Question 3

What does the law of demand state?

Answer 3

The law of demand states that in a given time period, the quantity demanded of a good is inversely related to its price, ceteris paribus.

Question 4

What is the Law of Diminishing Marginal Utility (LDMU)?

Answer 4

The LDMU explains that incremental units of satisfaction diminishes as a consumer consumes more units of a good.
It helps explain the negative slope of demand curve.

Question 5

List the factors affecting demand of a good.

Answer 5

• Change in consumers’ income (normal and inferior goods)
• Change in the price of related goods (substitutes, complements, goods in derived demand)
• Change in taste and preferences
• Change in government economic policies
• Expectations of future price changes
• Others (Change in availability of credit facilities and hire purchases / change in seasons / change in population)

Question 6

What is a normal good?

Answer 6

Normal goods are goods whose demand increases with increase in consumers’ income, vice versa.

Question 7

What is an inferior good?

Answer 7

Inferior goods are goods whose demand varies inversely with consumers’ income.

Question 8

What is a substitute good (competitive good/demand)?

Answer 8

A substitute good is an alternative good that can replace another because it satisfies the same wants. (e.g. Tea vs coffee)

Two goods are considered substitutes if a change in the price for one good causes demand for the other to change in the same direction.

Question 9

What is a complementary good (joint demand)?

Answer 9

A complementary good is a good which must be used at the same time with another to satisfy the same want (e.g. Coffee and milk)

Two goods are considered complements if a change in price for one good causes demand for the other to shift in the opposite direction.

Question 10

What are goods in derived demand?

Answer 10

Goods are in derived demand when a good is demanded not for its own sake but for its contribution in the manufacture of another product (e.g. Cars and steel)

A change in demand for the final good causes a similar change in demand for the relevant resource (the resource used in manufacture of the final good)

Question 11

Define supply.

Answer 11

Supply refers to the amount of a good producers are willing and able to sell at various prices over a given period of time, ceteris paribus.

Question 12

Define the law of supply.

Answer 12

The law of supply states that in a given time period, quantity supplied of a good is directly related to its price, ceteris paribus.

Question 13

List down the factors affecting supply of a good.

Answer 13

• Change in the price of factor inputs
• Change in production of related goods (Competitive supply, Joint supply)
• Change in state of technology
• Change in government policy
• Expectations of future price change
• Changes in the number of suppliers
• Change in weather conditions
• Others (natural disasters, wars etc.)

Question 14

What are goods in competitive supply?

Answer 14

A good in competitive supply is a good that uses some of the same resources as another good under consideration. (e.g. Milk used in butter and cheese)
Increase in production of one good will mean diverting some resources away from producing the other, due to scarcity.

Question 15

What are goods in joint supply?

Answer 15

Goods are joint supply are goods where the production of more of one leads to the production of more of the other (i.e. one is a by-product of the other).
(E.g. Beef and leather from cows)

Question 16

Define consumer surplus

Answer 16

Consumer surplus is the difference between what the consumer is willing and able to pay for a good and the actual price paid for it.

Question 17

Define producer surplus

Answer 17

Producer surplus is the difference between what the producer is willing and able to accept for supplying a good and the actual price received for it.

Question 18

Define labour demand

Answer 18

Labour demand is defined as the amount of labour that firms are able and willing to employ at the given wage, ceteris paribus.

Question 19

List down the factors affecting labour demand

Answer 19

• Changes in the production of goods and services (demand and supply for the product)
• Productivity of labour
• Technology
• Changes in price of other factor inputs
• Government policies (subsidy, foreign worker levy)

Question 20

What is a complementary factor input (in terms of labour)?

Answer 20

A complementary factor input is one that is used by the labour in the production process.

Question 21

What is a substitutable factor input (in labour)?

Answer 21

A substitutable factor input is one that can be used instead of a particular type of labour.

Question 22

Define labour supply

Answer 22

Labour supply is defined as the amount of labour that people are able and willing to provide at the given wage.

Question 23

List down the factors affecting labour supply

Answer 23

• Changes in labour force (immigration, population growth, ageing and retiring population, women)
• Changes in the size and composition of qualified workers
• Government policies (changing qualification required, subsidies for education and training, changing the incentive to work, adjusting retirement age, immigration policies)

Question 24

What are the effects of shortages?

Answer 24

• Queueing, in order to get the limited goods on sale
• Panic buying and rationing (buying usually large amounts)
• Formation of resale markets (scalping) and black markets (illegal market)

Question 25

What are the effects of surpluses?

Answer 25

• Wastage of resources (using scarce resources to produce more than needed)
• Rising cost for firms (surplus needs to be stored -> storage costs -> lower profits)