Chapter 4 | Demand and Supply

Question 1

Whats a Market?

Answer 1

Markets connect competition between buyers, competition between sellers, and cooperation between buyers and sellers. Government guarantees of property rights allow markets to function.

Question 2

Market

Answer 2

the interactions between buyers and sellers.

Question 3

Market Information

Answer 3

Because any purchase or sale is voluntary, an exchange between a buyer and seller happens only when both sides end up better off.

– Buyers are better off when businesses supply products or services that provide satisfaction (marginal benefit) that is at least as great as the price paid.
– Sellers are better off when the price received is at least as great as marginal opportunity costs.

Question 4

Property rights

Answer 4

legally enforceable guarantees of ownership of physical, financial, and intellectual property.

Question 5

Where Do Prices Come From? Price Signals from Combining Demand and Supply

Answer 5

When there are shortages, competition between buyers drives prices up. When there are surpluses, competition between sellers drives prices down.

Prices are the outcome of a market process of competing bids (from buyers) and offers (from sellers).

Question 6

When the market price turns out to be too low:

Answer 6

– shortage, or excess demand — quantity demanded exceeds quantity supplied.
– shortages create pressure for prices to rise.
– rising prices provide signals and incentives for businesses to increase quantity supplied and for consumers to decrease quantity demanded, eliminating the shortage.

Question 7

shortage, or excess demand

Answer 7

quantity demanded exceeds quantity supplied.

Question 8

What happens to prices when there are shortages

Answer 8

shortages create pressure for prices to rise.

Question 9

What do businesses do when there are rising prices

Answer 9

rising prices provide signals and incentives for businesses to increase quantity supplied and for consumers to decrease quantity demanded, eliminating the shortage.

Question 10

When the market price turns out to be too high:

Answer 10

– surplus, or excess supply — quantity supplied exceeds quantity demanded.
– surpluses create pressure for prices to fall.
– falling prices provide signals and incentives for businesses to decrease quantity supplied and for consumers to increase quantity demanded, eliminating the surplus.

Question 11

surplus, or excess supply

Answer 11

quantity supplied exceeds quantity demanded.

Question 12

What happens when there are surpluses

Answer 12

surpluses create pressure for prices to fall.

Question 13

What happens when there are falling prices

Answer 13

falling prices provide signals and incentives for businesses to decrease quantity supplied and for consumers to increase quantity demanded, eliminating the surplus.

Question 14

What happens when prices dont change

Answer 14

Even when prices don’t change, shortages and surpluses also create incentives for frequent quantity adjustments to better coordinate smart choices of businesses and consumers.

Question 15

When Prices Sit Still: Market-Clearing or Equilibrium Prices

Answer 15

Market-clearing or equilibrium prices balance quantity demanded and quantity supplied, coordinating the smart choices of consumers and businesses.

Question 16

The price that coordinates the smart choices of consumers and businesses has two names:

Answer 16

market-clearing price
equilibrium price

Question 17

market-clearing price

Answer 17

the price that equalizes quantity demanded and quantity supplied.

Question 18

equilibrium price

Answer 18

the price that balances forces of competition and cooperation, so that there is no tendency for change.

Question 19

Price Signals

Answer 19

Price signals in markets create incentives, so that while each person acts only in her own self-interest, the result (coordinated through Adam Smith’s invisible hand of competition) is the miracle of continuous, ever-changing production of the products and services we want.

Question 20

Moving Targets: What Happens When Demand and Supply Change?

Answer 20

When demand or supply change, equilibrium prices and quantities change. The price changes cause businesses and consumers to adjust their smart choices. Well-functioning markets supply the changed products and services demanded.

Question 21

For a change in demand (changes in preferences, prices of related products, income, expected future prices, number of consumers)

Answer 21

– an increase in demand (rightward shift of demand curve) causes a rise in the equilibrium price, and an increase in quantity supplied.
– a decrease in demand (leftward shift of demand curve) causes a fall in the equilibrium price, and a decrease in quantity supplied.

Question 22

For a change in supply (changes in technology, environment, prices of inputs, prices of related products produced, expected future prices, number of businesses)

Answer 22

– an increase in supply (rightward shift of supply curve) causes a fall in the equilibrium price and an increase in quantity demanded.
– a decrease in supply (leftward shift of supply curve) causes a rise in the equilibrium price and a decrease in quantity demanded.

Question 23

When both demand and supply change at the same time, we can predict the change in either the equilibrium price or in the equilibrium quantity. But without information about the relative size of the shifts of the demand and supply curves, we cannot predict what will happen to the other equilibrium outcome.

Answer 23

– when both demand and supply increase, the equilibrium price may rise/fall/remain constant, and the equilibrium quantity increases.
– when both demand and supply decrease, the equilibrium price may rise/fall/remain constant, and the equilibrium quantity decreases.
– when demand increases and supply decreases, the equilibrium price rises and the equilibrium quantity may rise/fall/remain constant.
– when demand decreases and supply increases, the equilibrium price falls, and the equilibrium quantity may rise/fall/remain constant.

Question 24

Comparative statics

Answer 24

comparing two equilibrium outcomes to isolate the effect of changing one factor at a time.

Question 25

Getting More Than You Bargained For: Consumer Surplus, Producer Surplus, and Efficiency

Answer 25

An efficient market outcome has the largest total surplus, prices just cover all opportunity costs of production and consumers’ marginal benefit equals businesses’ marginal cost.

Question 26

Reading demand and supply curves as marginal benefit and marginal cost curves reveals the concepts of:

Answer 26

– consumer surplus
– producer surplus
– total surplus
– deadweight loss

Question 27

producer surplus

Answer 27

the difference between the amount a producer is willing to accept, and the price actually received. The area below the market price but above the marginal cost curve.

Question 28

total surplus

Answer 28

consumer surplus plus producer surplus.

Question 29

deadweight loss

Answer 29

decrease in total surplus compared to an economically efficient outcome.

Question 30

Efficient market outcome

Answer 30

coordinates smart choices of businesses and consumers so

– consumers buy only products and services where marginal benefit is greater than price.
– product and services are produced at lowest cost, with prices just covering all opportunity costs of production.
– at the quantity of an efficient market outcome, marginal benefit equals marginal cost (MB = MC).