Introduction, Supply and Demand

Question 1

Trade-Offs (society faces 3 key trade-offs)

Answer 1

1. Which goods and services to produce: if society produces more cars, it must produce fewer of other goods and services because resources (workers, raw material, capital, energy) is limited
2. How to produce: which raw materials to use to produce a good, depending on which is less expensive / quality
3. Who gets the goods and services: the more of society’s goods & services you receive, the less someone else gets

Question 2

Market

Answer 2

An exchange mechanism that allows buyers to trade with sellers

Single market: refers to a market for a single good or a group of goods, such as Fuji apples, soft drinks, movies, automobiles

Question 3

Model

Answer 3

A description of the relationship between two or more economic variables

Strongly built on assumptions to simplify the model - e.g. assuming the consumers know the price each firm charges, or assuming the color of the car does not have an impact on the number of cars bought

Question 4

Positive and Normative Statements

Answer 4

Positive Statement: a testable hypothesis about cause and effect - it indicates that the truth of te statement is testable

Normative statement (a value judgement): a conclusion as to whether something is good or bad - untestable because value judgement cannot be refuted by evidence

Normative statement is what someone believes Should happen, whereas a positive statement concerns what Will happen

Example: positive statement: if an African government use price control to keep price of food low during a drought, this will lead to food shortages and people will starve. A normative statement: because people should have prepared for the drought, the government should not try to help by keeping food prices low OR people should be protected against price gouging during a drought so the government should use price controls

Question 5

How governments use microeconomic models

Answer 5

Predict the probable impact of a policy before it is adopted, such as effects of tariffs and quotas on trade

Question 6

Competitive markets

Answer 6

Markets with many buyers and sellers, such as most agriculture markets, labor markets, stock and commodity markets

Supply-and-demand only works for competitive markets

Question 7

Demand

Answer 7

The quantity of a good or service that consumers demand depends on price and other factors, such as consumers income and the price of related goods

Question 8

Supply

Answer 8

The quantity of a good or service that firms supply depends on price and other factors, such as the cost of inputs firms use to produce the good or service

Question 9

Market Equilibrium

Answer 9

The interaction between consumers’ demand and firms’ supply determines the market price and quantity of a good or service that is bought and sold

Question 10

Shocking the Equilibrium

Answer 10

Changes in a factor that affect demand (e.g. changes in consumers’ incomes), supply (e.g. rise in price of raw materials), or a new government policy (e.g. a new sugar tax), will alter the market price and quantity of a good

Shifts in the demand curve or the supply curve cause the equilibrium to change

Question 11

Effects of Government Interventions

Answer 11

Government policies may alter the equilibrium and cause the quantity supplied to differ from the quantity demanded

Question 12

When to use the Supply-and-Demand Model

Answer 12

The supply-and-demand model applies only to competitive markets

Question 13

Factors influencing demand (other than price)

Answer 13

Cause a SHIFT of the demand curve (price cause movement along the demand curve)

Consumers tastes - advertisement may influence people’s tastes

Information (or misinformation) about characteristics of a good (e.g. this good is healthy, this lowers cholesterol)

Price of other goods - substitures as well as complementary goods

Income - an increase in income might cause demand for DIY kits to decrease

Government rules and regulations - sales tax, usage bans

Question 14

Quantity demanded

Answer 14

The amount of a good that consumers are willing to buy at a given price, holding constant the other factors that influence purchase

Question 15

Demand curve

Answer 15

The quantity demanded at each possible price, holding constant the other factors that influence purchases

Question 16

Law of Demand

Answer 16

Consumers demand more of a good the lower its price, holding constant other factors that influence consumption

Question 17

Demand function

Answer 17

Q = D(p) and includes all the factors you do not want to hold constant - so if you want to incorporate the effect of the price of sugar, it could be Q = D(p, ps)

Question 18

Factors influencing supply (other than price)

Answer 18

Cause a SHIFT in the supply curve (price cause movement along the supply curve)

Cost of production - when the cost of production falls, the firm supplies more, but if it exceeds what they can earn from selling the good, they sell nothing

Government rules and regulations - how much they want to sell, whether they may sell that product, such as taxes, polution, health insurance

Question 19

Examples of government policies’ effects on supply curves

Answer 19

Licensing laws: limits the number of firms that may sell goods in a market, could be zoning laws limiting number of bars or hotel chains or licenses required in certain occupations where a tests must be passed, which limits the members of the occupation

Quotas: usually limit the amount of a good that firms may sell (not a limit on the number of firms) - often to limit imports.

Question 20

Quantity supplied

Answer 20

The amount of a good that firms want to sell at a given price, holding constant other factors that influence firms’ supply decisions, such as costs and government actions

Question 21

Supply curve

Answer 21

The quantity supplied at each possible price, holding constant the other factors that influence firms’ supply decisions

Question 22

Supply function

Answer 22

Q = S(p) and includes all the factors you do not want to hold constant - so if you want to incorporate the effect of the price of cocoa, it could be Q = S(p, pc)

Question 23

Equilibrium

Answer 23

A situation in which no one wants to change his or her behavior - where supply and demand meet.

Question 24

Equilibrium price

Answer 24

The price at which the consumers can buy as much as they want and sellers can sell as much as they want

Also called the market clearing price, because it removes from the market all frustrated buyers and sellers (the market has no excess demand or excess supply)

Question 25

Equilibrium quantity

Answer 25

The amount that consumers buy and suppliers sell at the equilibrium price

Question 26

Excess demand

Answer 26

The amount by which the quantity demanded exceeds the quantity supplied –> the price is too low for an equilibrium

This would cause an upward pressure on price until it reaches equilibrium price

Question 27

Excess supply

Answer 27

The amount by which the quantity supplied exceeds the quantity demanded –> the price is too high for an equilibrium

Downward pressure on price until it reaches equilibrium price

Question 28

Shocking the equilibrium

Answer 28

Shifts in the demand curve or the supply curve cause the equilibrium to change

Question 29

Examples of government policies causing excess demand / excess supply

Answer 29

Price ceilings: have no effect if they are set above the equilibrium price, but if the price ceiling is below the equilibrium price, it causes excess demand

Price floors: such as minimum wage. Have no effect if they are set below the equilibrium price, but above the equilibrium price, it causes excess supply

Question 30

Ideal conditions for markets in which to apply the supply and demand model

Answer 30

Perfectly competitive markets, meaning:
Many firms and consumers in the market, so no one is a large enough part of the market to affect the price –> consumers and firms are price takers
Firms sell identical products: consumers do not prefer one firm’s good to another
Everyone has full information about the price and quality of goods: consumers know if one firm is charging more than the others, and they know if the firms try to sell inferior-quality goods
Costs of trading are low: (transaction cost) it is not time consuming, difficult or expensive for a buyer to find a seller and make a trade or for a seller to find and trade with a buyer

Examples of markets where it is useful: agriculture, finance, labor, construction, services, wholesale, retail

This means the supply and demand model is not appropriate in markets with only one or few firms (e.g. electricity), differentiated products (e.g. movies), consumers who know less than sellers about quality and price (e.g. used cars) or high transaction costs (e.g. nuclear turbine engines)