Demand, Supply, Market Equilibrium, and Welfare Analysis

Question 1

Law of Demand

Answer 1

holding all else equal, when the price of a good rises, consumers decrease their quantity demanded for that good

Question 2

ceteris paribus

Answer 2

a Latin phrase literally translated as “with other things the same” or “all other things held equal/constant”; it is an assumption made that no variables are changing other than the two being addressed

Question 3

absolute/money prices

Answer 3

the price of a god measured in units of currency

Question 4

relative prices

Answer 4

the number of units of any other good Y that must be sacrificed to acquire the first good X; only relative prices matter

Question 5

substitution effect

Answer 5

the change in quantity demanded resulting from a change in the price of one good relative to the price of other goods

Question 6

income effect

Answer 6

the change in quantity demanded that results from a change in the consumer’s purchasing power (or real income)

Question 7

demand schedule

Answer 7

a table showing quantity demanded for a good at various prices

Question 8

demand curve

Answer 8

a graphical depiction of the demand schedule; the demand curve is downward sloping, the inverse of the Law of Demand

Question 9

determinants of demand

Answer 9

the external variables that shift demand to the left or right; they include:

• consumer income
• the price of a substitute good
• the price of a complementary good
• consumer tastes and preferences
• consumer expectations about future prices
• number of buyers in the market

Question 10

normal goods

Answer 10

goods for which higher income increases demand

Question 11

inferior goods

Answer 11

goods for which higher income decreases demand

Question 12

substitute goods

Answer 12

two goods are consumer substitutes if they provide essentially the same utility to the consumer; a Honda Accord and a Toyota Camry might be substitutes for each other for many people

Question 13

complementary goods

Answer 13

goods that provide more utility consumed with an original good when consumed together than both do when they are consumed separately; a 35mm camera and a roll of film are complementary goods

Question 14

Law of Supply

Answer 14

holding all else equal, when the price of a good rises, suppliers increase their quantity supplied for that good

Question 15

supply schedule

Answer 15

a table showing quantity supplied for a good at various prices

Question 16

supply curve

Answer 16

a graphical depiction of the supply schedule; the supply curve is upward sloping, reflecting the Law of Supply

Question 17

determinants of supply

Answer 17

the external variables that influence supply; when these variables change, the entire supply curve shifts to the left or right; they include:

• the cost of an input for production (any economic resource)
• taxes or subsidies
• producer expectations about future prices
• the prices of other goods in the market, especially similar ones
• the number of competitors

Question 18

market equilibrium

Answer 18

exists at the only price where the quantity supplied equals the quantity demanded; or, it is the only quantity where the price consumers are willing to pay is exactly the price the producers are willing to accept

Question 19

shortage

Answer 19

also known as excess demand, a shortage exists at a market price when the quantity demanded exceeds the quantity supplied; the price rises to eliminate a shortage

Question 20

disequilibrium

Answer 20

any price where the quantity demanded is not equal to the quantity supplied

Question 21

surplus

Answer 21

also known as excess supply, a surplus exists at a market price when the quantity supplied exceeds the quantity demanded; the price falls to eliminate a surplus

Question 22

total welfare

Answer 22

the sum of the consumer surplus and producer surplus; the free market equilibrium provides maximum combined gain to society

Question 23

consumer surplus

Answer 23

the difference between your willingness to pay and the price you actually pay; it is the area below the demand curve and above the price

Question 24

producer surplus

Answer 24

the difference between the price received and the marginal cost of producing the good; it is the area above the supply curve and under the price