Chapter 3 - Where Prices Come From: The Interaction of Demand and Supply

Question 1

Demand schedule

Answer 1

A table that shows the relationship between the price of a product and the quantity of the product demanded.

Question 2

Quantity demanded

Answer 2

The amount of a good or service that a consumer is willing and able to purchase at a given price.

Question 3

Demand curve

Answer 3

A curve that shows the relationship between the price of a product and the quantity of the product demanded.

Question 4

Market demand

Answer 4

The demand by all the consumers of a given good or service.

Question 5

Law of Demand

Answer 5

While holding everything else constant, when the price of a product falls, the quantity demanded of the product will increase.

And when the price of a product rises, the quantity demanded of the product will decrease.

Question 6

Substitution effect

Answer 6

The change in the quantity demanded of a good that results from a change in price, making the good more or less expensive relative to other goods that are substitutes.

Question 7

Income effect

Answer 7

The change in the quantity demanded of a good that results from the effect of a change in the good’s price on consumers’ purchasing power.

Question 8

Consumer purchasing power

Answer 8

Measures the value in money for which consumers may purchase goods or services. Consumer purchasing power indicates the degree to which inflation (rise in price) affects consumers’ ability to buy.

Question 9

Ceteris paribus (“all else equal”) condition

Answer 9

The requirement that when analyzing the relationship between two variables—such as price and quantity demanded— other variables must be held constant.

Question 10

Shift of a demand curve

Answer 10

An increase or decrease in demand

The curve moves entirely

Question 11

Movement along a demand curve

Answer 11

An increase or decrease in the quantity demanded

Value changes on the current curve

Question 12

What are the 5 variables that shift market demand?

Answer 12

1) Income
2) Prices of related goods
3) Tastes
4) Population and Demographics
5) Expected Future Prices

Question 13

How does the 1st variable (Income) shift market demand?

Answer 13

For normal goods, the demand increases as the income increases. And vice versa
Ex. New cars, branded clothes

For inferior goods, the demand decreases as the income increases. And vice versa.
Ex. Used cars, used clothes

Question 14

Normal good

Answer 14

A good for which the demand increases as income rises and decreases as income falls

Ex. Branded items

Question 15

Inferior good

Answer 15

A good for which the demand increases as income falls and decreases as income rises

Ex. Used item

Question 16

How does the 2nd variable (Prices of related goods) shift market demand?

Answer 16

There are two types of related goods, substitutes and complements.

For substitutes, an increase in the price of one increases the demand for the other. For example, if Coca-Cola increases their price, consumers will prefer Pepsi because the price is lower.

For complements, an increase in the price of one decreases the demand for the other. For example, if the price of pens goes up, consumers will purchase fewer pens therefore the demand for paper will decrease as well.

Question 17

Substitutes

Answer 17

Two goods are called substitutes, if:

1. Goods and services that can be used for the same purpose
2. Increase in the price of one, increases the demand for other

Ex. An increase in the price of Coca-Cola will increase demand for Pepsi

Question 18

Complements

Answer 18

Two goods are called complements, if:

1. Goods and services that are used together.
2. Increase in the price of one, decreases the demand for other

Ex. An increase in the price of pens will decrease the demand for Pepsi

Question 19

How does the 3rd variable (Tastes) shift market demand?

Answer 19

Tastes include subjective elements such as ad campaigns that can affect a consumer’s decision to buy a product.

Ex. In winter, coffee is preferred but in summer, a smoothie is preferred

Question 20

How does the 4th variable (Population and Demographics) shift market demand?

Answer 20

Every location will have people of different ages, ethnicities, religions, genders etc. These affect the market demand in that area.

Ex. A growing city will have more demand at every price. A city with more youth will prefer better education over better healthcare.

Question 21

Demographics

Answer 21

The characteristics of a population with respect to age, race, and gender

Question 22

How does the 5th variable (Expected future prices) shift market demand?

Answer 22

Consumers choose not only which products to buy but also when to buy them

Ex. Purchasing gas for their vehicle another day when the price is lower

Question 23

Quantity supplied

Answer 23

The amount of a good or service that a firm is willing and able to supply at a given price

Question 24

Supply schedule

Answer 24

A table that shows the relationship between the price of a product and the quantity of the product supplied

Question 25

Supply curve

Answer 25

A curve that shows the relationship between the price of a product and the quantity of the product supplied

Question 26

Law of Supply

Answer 26

While holding everything else constant, increases in price cause increases in the quantity supplied.

Decreases in price cause a decrease in the quantity supplied

Question 27

What are the 5 variables that shift market supply?

Answer 27

1) Prices of inputs
2) Technological change
3) Prices of substitutes in production
4) Number of firms in the market
5) Expected future prices

Question 28

How does the 1st variable (Prices of inputs) shift market supply?

Answer 28

A change in the price of an input—anything used in the production of a good or service—is the most likely factor to cause the supply curve for a product to shift.

If there is an increase in the price of an input, the supply curve shifts to the left because the costs of producing the good increase.

Question 29

How does the 2nd variable (Technological change) shift market supply?

Answer 29

A positive or negative change in the ability of a firm to produce a given level of output with a given quantity of inputs.

If there is an increase in productivity (technological change), the supply curve shifts to the right as the costs of producing the good decrease.

Ex. Machines improve therefore improved production

Question 30

How does the 3rd variable (Prices of substitutes in production) shift market supply?

Answer 30

Alternative products that a firm could produce are called substitutes in production.

If the price of a substitute in production increases, the supply curve shifts to the left because more of the substitute is produced and less of the good is produced.

Question 31

How does the 4th variable (Number of firms in the market) shift market supply?

Answer 31

A change in the number of firms in the market will change supply.

If there is an increase in the number of firms in the market, the supply curve will shift to the right because additional firms result in a greater quantity supplied at every price.

Question 32

How does the 5th variable (Expected future prices) shift market supply?

Answer 32

If a firm expects that the price of its product will be higher in the future than it is today, it has an incentive to decrease supply now and increase it in the future.

If there is an increase in the expected future prices of a good, the supply curve will shift to the left because less of the good will be offered for sale today to take advantage of the higher prices in the future.

Question 33

Shift of a supply curve

Answer 33

An increase or decrease in supply

The curve moves entirely

Question 34

Movement along a supply curve

Answer 34

An increase or decrease in the quantity supplied

Value changes on the current curve

Question 35

Market equilibrium

Answer 35

Where the demand curve crosses the supply curve. At market equilibrium, quantity demanded (Qd) equals quantity supplied (Qs).

Question 36

Equilibrium price

Answer 36

The price at market equilibrium

Question 37

Equilibrium quantity

Answer 37

The quantity at market equilibrium

Question 38

Competitive market equilibrium

Answer 38

A market equilibrium with many buyers and many sellers

Question 39

Surplus

Answer 39

A situation in which the quantity supplied is greater than the quantity demanded. Decreasing the price is recommended.

When the market price is above market equilibrium, there will be a surplus.

Question 40

Shortage

Answer 40

A situation in which the quantity demanded is greater than the quantity supplied. Increasing the price is recommended.

When the market price is below market equilibrium, there will be a shortage

Question 41

Can anyone dictate what the equilibrium price will be?

Answer 41

No! Neither consumers nor firms can dictate what the equilibrium price will because no firm can sell anything at any price unless it can find a willing buyer. Similarly, no consumer can buy anything at any price without finding a willing seller.

Question 42

Demand formula

Answer 42

Qd = 50 - 5P

In this case: 
Qd = Quantity demanded
50 = constant
5 = slope of the demand curve
P = price

And there is a negative (-) sign because the relationship between price and quantity demanded is negative as seen by the downward sloping demand curve on graphs.

Question 43

Supply formula

Answer 43

Qs = 5 + 10P

In this case: 
Qs = Quantity supplied
5 = constant
10 = slope of the supply curve
P = price

And there is a positive (+) sign because the relationship between price and quantity demanded is positive as seen by the upward sloping supply curve on graphs.