Markets, demand & supply

Question 1

Law of demand

Answer 1

The quantity of good demanded per period of time will fall as price rises and will rise as price falls, other things being equal

Question 2

Income effect

Answer 2

The effect of a change in price on quantity demanded arising from the consumer becoming better or worse off as a result of the price change

Question 3

Substitution effect

Answer 3

The effect of a change in price on quantity demanded arising from the consumer switching to or from alternative (substitute) products

Question 4

Quantity demanded

Answer 4

The amount of a good that a consumer is willing and able to buy at a given price over a given period of time

Question 5

Demand schedule for an individual

Answer 5

A table showing the different quantities of a good that a person is willing and able to buy at a given price over a given period of time

Question 6

Market demand schedule for an individual

Answer 6

A table showing the different quantities of a good that consumers are willing and able to buy at various prices over a given period of time

Question 6

Demand curve

Answer 6

A graph showing the relationship between the price of a good and the quantity of the good demanded over a given time period. Price is measured on the vertical axis. Quantity demanded is measured on the horizontal axis. A demand curve can be for an individual consumer or a group of consumers, or more usually for the whole market.

Question 7

Substitute goods

Answer 7

A pair of goods that are considered by consumers to be alternatives to each other. As the price of one goes up, the demand for the other rises.

Question 8

Complementary goods

Answer 8

A pair of goods consumed together. As the price of one goes up, the demand of both goods will fall

Question 9

Normal good

Answer 9

A good whose demand rises as people’s incomes rise

Question 10

Inferior good

Answer 10

A good whose demand falls as people’s incomes rise

Question 10

Ceteris paribus

Answer 10

Latin for ‘other things being equal’. This assumption has to be made when making deductions from theories

Question 11

Change in demand

Answer 11

The term used for a shift in the demand curve. It occurs when a determinant of demand other than price changes

Question 12

Change in the quantity demanded

Answer 12

The term used for a movement along the demand curve to a new point. It occurs when there is a change in price

Question 13

Principle of diminishing marginal utility

Answer 13

As more units of a good are consumed, additional units will provide less additional satisfaction than previous units

Question 14

Marginal utility (MU)

Answer 14

The extra satisfaction gained from consuming one extra unit of a good within a given time period

Question 15

Rational consumer behavior

Answer 15

The attempt to get as much value as possible from your money when purchasing a good. If MU>P, you will buy more; if MU<P, you will buy less (or not buy at all); if MU=P, you will maintain your level of consumption

Question 16

Consumer surplus

Answer 16

The excess of what a person would have been prepared to pay for a good (i.e. the utility) over what that person acctually pays

Question 17

Marginal customer surplus

Answer 17

The excess of utility from the consumption of one more unit of a good (MU) over the price paid: MCS= MU - P

Question 18

Total consumer surplus

Answer 18

The excess of a person’s total utility from the consumption of a good (TU) over the total amount that person spends on it (TE): TCS = TU - TE

Question 19

Rational consumer behaviour (alternative definition)

Answer 19

The attempt to maximise total consumer surplus

Question 20

Supply schedule

Answer 20

A table showing the different quantities of a good that producers are willing and able to supply at various prices over a given time period. A supply schedule can be for an individual producer or group of producers, or for all producers (the market supply schedule)

Question 21

Supply curve

Answer 21

A graph showing the relationship between the price of a good and the quantity of the good supplied over a specified period of time

Question 22

Substitutes in supply

Answer 22

These are two goods where an increased production of one means diverting resources away from producing the other

Question 23

Goods in joint supply

Answer 23

These are two goods where the production of more of one leads to the production of more of the other

Question 24

Change in the quantity supplied

Answer 24

The term used for a movement along the supply curve to a new point. It occurs when there is a change in price

Question 25

Change in supply

Answer 25

The term used for a shift in the supply curve. It occurs when a determinant other than price changes

Question 26

Market cleaning

Answer 26

A market cleans when supply matches demand, leaving no shortage or surplus

Question 27

Bounded rationality

Answer 27

When the ability to make rational decisions is limited by lack of information or the time necessary to obtain such information

Question 28

Heuristics

Answer 28

People’s use of strategies that draw on simple lessons from past experience when they are faced with similar, although not identical, choices

Question 29

when the price of a good rises the quantity demanded per period of time will…

Answer 29

fall. This is known as the “law of demand”. It applies both to individuals’ demand and to the whole market demand

Question 30

The law of demand is explained by

Answer 30

the income and substitution effects of a price change

Question 31

The relationship between price and quantity demanded per period of time can be shown…

Answer 31

in a table(or “schedual”) or as a graph. On the graph, price is plotted on the vertical axis and quantity demanded per period of time on the horizontal axis. The resulting demand curve is downward sloping(negatively sloped)

Question 32

Other determinants of demand include…

Answer 32

tastes, the number and substitute goods, the number and price of complementary goods, income, the distribution of income and expectations of future price changes

Question 33

If price changes

Answer 33

the effect is shown by a movement along the demand curve. We call this effect ”a change in the quantity demanded”

Question 34

if any other determinant of demand changes

Answer 34

the whole curve will shift. We call this effect “a change in demand”. A rightward shift represents an increase in demand; a leftward shift represents a decrease in demand

Question 35

consumers will attempt to get the best value from

Answer 35

their money when buying goods. They will do this by consuming more of a good as long as its marginal utility to them (measured in terms of the price they are prepared to pay for it) exceeds its price. But as they buy more, marginal utility will diminish. They will stop buying additional amounts once MU has fallen to equal the price.

Question 36

An individual’s demand curve lies

Answer 36

along the same line as the individual’s marginal utility curve. The market demand curve is the sum of all individuals’ marginal utility curves.

Question 37

When the price of a good rises the quantity supplied per period of time will usually…

Answer 37

also rise. This applies both to individual producers’ supply and to the whole market supply.

Question 38

There are two reasons in the short run why a higher price encourages producers to supply more:

Answer 38

(a) they are now willing to incur higher costs per unit associated with producing more; (b) they will switch to producing this product instead of now less profitable ones. In the long run there is a third reason: new producers will be attracted into the market.

Question 39

The relationship between price and quantity supplied per period of time can be shown in

Answer 39

a table (or schedule) or as a graph. As with a demand curve, price is plotted on the vertical axis and quantity per period of time on the horizontal axis. The resulting supply curve is upward sloping (positively sloped).

Question 40

Other determinants of supply include the costs of

Answer 40

production, the profitability of alternative products, the profitability of goods in joint supply, random shocks and expectations of future price changes.

Question 41

If price changes,

Answer 41

the effect is shown by a movement along the supply curve. We call this effect ‘a change in the quantity supplied.

Question 42

If any determinant other than price changes,

Answer 42

the effect is shown by a shift in the whole supply curve. We call this effect ‘a change in supply. A rightward shift represents an increase in supply; a leftward shift represents a decrease in supply.

Question 43

If the demand for a good exceeds the supply

Answer 43

there will be a shortage. This will lead to a rise in the price of the good.

Question 44

If the supply of a good exceeds the demand

Answer 44

there will be a surplus. This will lead to a fall in the price.

Question 45

Price will settle at the

Answer 45

equilibrium. The equilibrium price is the one that clears the market: the price where demand equals supply.

Question 46

If the demand or supply curve shifts

Answer 46

this will lead either to a shortage or to a surplus. Price will therefore either rise or fall until a new equilibrium is reached at the position where the supply and demand curves now intersect.

Question 47

A free-market economy functions

Answer 47

automatically, and if there is plenty of competition between producers, this can help to protect consumers’ interests.

Question 48

In practice, however, competition may be limited:

Answer 48

there may be great inequality; there may be adverse social and environmental consequences; there may be macroeconomic instability. Consequently, governments intervene in market economies in various ways in order to correct the failings of the free market.

Question 49

Traditional economics is based on

Answer 49

on the premise that consumers act rationally, weighing up the costs and benefits of the choices open to them. Behavioural economics acknowledges that real-world decisions do not always appear rational; it seeks to understand and explain what economic agents actually do.

Question 50

A number of effects can explain why rational decision making may

Answer 50

fail to predict actual behaviour. These include: the roles of framing and relativity; individuals failing to disregard sunk costs and being confused by too many choices. Research undertaken by behavioural economists is bringing together aspects of psychology and economics, in order to understand fully how we behave.