Module 2 - Demand And Supply

Question 1

Law of demand

Answer 1

The quantity of a good demanded per period of time will fall as the price rises and rise as the price falls, other things being equal (or ceteris paribus)

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 a 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 willing and able to buy at a given price over a given time period

Question 5

Demand curve

Answer 5

A graph showing the relationship between the price of a good and the quantity of the good demanded over a given time period. It’s drawn with price on the vertical axis and quantity on the horizontal axis and the law of demand suggests that it slopes downwards.

Question 6

7 factors that influence the demand of a good

Answer 6

1. Price
2. Consumer tastes
3. The number and price of substitute goods
4. The number and price of complementary goods
5. Consumer incomes
6. The distribution of income
7. Expectations of future price changes

Question 7

Substitute goods

Answer 7

A pair of goods which are considered by consumers to be alternatives to each other. As the price of one increases 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 for both goods will fall.

Question 9

Normal goods

Answer 9

Goods whose demand rises as people’s incomes rise. Most goods are normal goods.

Question 10

Inferior goods

Answer 10

Goods whose demand falls as people’s incomes rise.

Question 11

Change in demand

Answer 11

The term used for a shift in the demand curve, which 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, which occurs when there is a change in price.

Question 13

Three reasons why quantity supplied increases with price

Answer 13

1. Beyond a certain output level, costs are likely to rise more and more rapidly as firms supply more. So it will be worthwhile producing more and incurring those higher costs if prices rise.
2. The higher the price of a good, the more profitable it becomes to produce. So firms will be encouraged to produce more of it by switching production from less profitable goods.
3. Given time, if the price of a good remains high, new firms will set up production-so total market supply increases.

The first two factors influence the short term supply whereas the last one influences supply in the long run.

Question 14

Supply curve

Answer 14

A graph showing the relationship between the price of a good and the quantity of the good supplied over a given time period. It’s drawn with price on the vertical axis and quantity on the horizontal axis and typically sloped upwards.

Question 15

8 factors that influence the supply of a good

Answer 15

1. Price
2. The costs of production and distribution
3. The profitability of alternative products (substitutes in supply)
4. The profitability of goods in joint supply
5. Nature, random shocks and other unpredictable events e.g. extreme weather, earthquakes
6. The aims of producers, e.g. maximising sales rather than profits
7. Expectations of future price changes
8. The number of suppliers

Question 16

4 factors for a change in production costs

Answer 16

1. Changes in input prices e.g. wages, rent, raw material prices
2. Changes in technology
3. Organisational changes
4. Changes in government policy, e.g. with regard to indirect taxes and subsidies on expenditure

Question 17

Substitutes in supply

Answer 17

Two goods where an increased production of one means diverting resources away from producing the other.

Question 18

Goods in joint supply

Answer 18

Two goods where the production of more of one leads to the production of more of the other.

Question 19

Change in supply

Answer 19

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

Question 20

Change in the quantity supplied

Answer 20

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

Question 21

Market clearing

Answer 21

A market clears when supply matches demand leaving no shortage or surplus. The price at which demand equals supply is the equilibrium price or market clearing price.

Question 22

Price taker

Answer 22

A person or a firm with no power to be able to influence the market price.

Instead a firm must accept the market price as given. If it tries to sell at above the market price, it will lose all its sales to rival firms.

Question 23

Free market

Answer 23

One which there is an absence of government intervention. Individual producers and consumers are free to make their own economic decisions.

Question 24

Price mechanism

Answer 24

The system in a market economy whereby changes in price in response to changes in demand and supply have the effect of making demand equal to supply.

Question 25

Equilibrium

Answer 25

A position of balance from which there is no tendency to move away from current prices and quantities

Question 26

Equilibrium price

Answer 26

The price where the quantity demanded equals the quantity supplied: the price where there is no shortage or surplus.

Question 27

Relationship between goods and factor markets

Answer 27

Goods market:

• Demand for the good rises
• This causes a shortage
• This causes the price of a good to rise
• This eliminates the shortage by choking off some of the demand and encouraging firms to produce more

Factor market:

• The increased supply of the good causes an increase in the demand for factors of production used in making it
• This causes a shortage of those inputs
• This causes their prices to rise
• This eliminates their shortage by choking off some of the demand and encouraging the suppliers of inputs to supply more

Question 28

Maximum price

Answer 28

A price ceiling set by the government or some other agency. The price is not allowed to rise above this level.

Question 29

Minimum price

Answer 29

A price floor set by the government or some other agency. The price is not allowed to fall below this level.

Question 30

Market clearing

Answer 30

A market clears when supply matches demand leaving no shortage or surplus. The price at which demand equals supply is the equilibrium price or market clearing price.

Question 31

Price taker

Answer 31

A person or firm with no power to be able to influence the market price. Instead it must accept the market price as given. If a firm tries to sell above the market price, it will lose all its sales to rival firms.

Question 32

Free market

Answer 32

A free market is one where there is no government intervention; instead individual producers and consumers are free to make their own economic decisions.

Question 33

Price mechanism

Answer 33

The system i a market economy whereby changes in price in response to changes in demand and supply have the effect of making demand equal to supply.

Question 34

Equilibrium

Answer 34

A position of balance from which there is no tendency to move away from current prices and quantities.

Question 35

Equilibrium price

Answer 35

The price where the quantity demanded equals the quantity supplied: the price where there is no shortage or surplus.

Question 36

Relationship between the goods and factor markets

Answer 36

Goods market:

• Demand for good rises.
• This creates a shortage.
• This causes the price of the good to rise.
• This eliminates the shortage by choking off some of the demand and encouraging firms to produce more.

Factor market:

• The increased supply of the good causes an increase in the demand for factors of production (inputs) used in making it.
• This causes shortage of those inputs.
• This causes their prices to rise.
• This eliminates their shortage by choking off some of the demand and encouraging the suppliers of inputs to supply more.

Question 37

Maximum price

Answer 37

A price ceiling set by the government or some other agency. The price is not allowed to rise above this level.

Question 38

Minimum price

Answer 38

A price floor set by the government or some other agency. The price is not allowed to fall below this level.