Unit 2: Demand, Supply and Price Determination

Question 1

Market

Answer 1

a system where buyers and sellers interact to exchange goods, services or resources. In a market there is demand and supply. The higher the number of buyers and sellers, the more competitive the market is.

Question 2

Types of Markets

Answer 2

1. Product Market
2. Factor Market
3. Financial Market

Question 3

Normal Goods

Answer 3

goods for which demand increases as income rises and vice versa

e.g. clothing, as people earn more money, they tend to buy more or higher quality clothing

Question 4

Inferior Goods

Answer 4

goods for which demand decreases as income rises and increases as income falls ceteris paribus.

e.g. instant noodles, when people have lower incomes, they buy more instant noodles as a cheap food option.

Question 5

Demand

Answer 5

amount buyers are willing and financially able to buy at a specific price during a particular period of time

Question 6

Law of Demand

Answer 6

Buyers tend to buy less at higher prices, ceteris paribus

Question 7

Why does the Demand curve slope downwards

Answer 7

Substitution effect and Income effect

Question 8

Substitution Effect (S.E.)

Answer 8

The substitution effect occurs when a change in the price of a good causes consumers to switch to or substitute that good with another similar, but cheaper good. The extent depends on the number and closeness of substitutes

e.g. if the price of butter increases, consumers may look for a cheaper alternative and start buying margarin instead

Question 9

Income Effect

Answer 9

refers to the change in the quantity demanded of a good or service as a result of a change in a consumer’s real income or purchasing power. The extent depends on the proportion spent on the good relative to income

e.g. if the price of coffee decreases, people have more money left over in their budget after purchasing the coffee, effectively increasing you real income or purchasing power

Question 10

Demand Curve

Question 11

Movement along vs shift (demand)

Answer 11

Movement along: caused by a change in the product’s own price

Shift: caused by a change in anything other than the product’s own price

Question 12

Competitive Demand vs Joint Demand

Answer 12

Competitive Demand: they are alternatives to each other, meaning that if the price of one good increases, the demand for the other good will likely increase as well

e.g. Pepsi and Coca-Cola

Joint Demand: they are used together, so the demand for one good is directly related to the demand for another. An increase in the demand for one good leads to an increase in the demand for the other

e.g. printers and ink

Question 13

Determinants of demand

Answer 13

1. Price of the good or service
2. Income levels (normal vs inferior goods)
3. Price of other goods (complementary or substitutes)
4. Consumer preferences
5. Expectations
6. Population
7. Advertising

Question 14

Supply

Answer 14

amount suppliers are prepared to sell at a specific price during a particular period of time

Question 15

Law of Supply

Answer 15

suppliers are prepared to sell more at higher prices, ceteris paribus

Question 16

Why does the Supply curve slope upwards

Answer 16

1. Profit Motive
2. Diminishing Returns

Question 17

Diminishing Returns

Answer 17

for one additional unit of output, more and more factor inputs are required, hence costs rise so price increases

Question 18

Profit Motive

Answer 18

refers to the drive or incentive for firms to maximize their profits i.e. charge more, sell more

Question 19

Supply Curve

Answer 19

shows how much a seller is prepared to sell at different market prices

Question 20

Movement along vs shift (supply)

Answer 20

Movement along: caused by a change in the product’s own price

Shift: caused by a change in anything other than the product’s own price

Question 21

Competitive Supply vs Joint Supply

Answer 21

Competitive Supply: goods produced using the same resources, meaning producing more of one good reduces the resources available to produce another

e.g. rice or sugarcane, electricity or heat

Joint Supply: when the production of one good automatically results in the production of another.

e.g. beef and leather, petrol, diesel and kerosene

Question 22

Determinants of Supply

Answer 22

1. Price of the good or service
2. Cost of production
3. Prices of related goods (complementary or substitutes)
4. Expectations
5. Number of sellers
6. Natural conditions

Question 23

Equilibrium

Answer 23

price at which both parties satisfy their plans simultaneously. There is no motive to change price, resulting in a stable market condition.

Question 24

Disequilibrium

Answer 24

price at which only one party fulfills its intentions, the other is left dissatisfied

Question 25

Dissatisfied buyers

Answer 25

buyers are dissatisfied when they cannot purchase the quantity of goods they want at the prevailing price, this occurs when demand exceeds supply, leading to a shortage in the market.

Price is below the equilibrium level and there are not enough goods available for all buyers willing to pay at the current price

Sellers’ market

Question 26

Dissatisfied Suppliers

Answer 26

suppliers are dissatisfied when they cannot sell all the goods they have produced at the prevailing price. This occurs when supply exceeds demand, leading to a surplus in the market

Price is above the equilibrium level, there are more goods in the market than buyers are willing to purchase at the current price

Buyers’ market

Question 27

Market mechanism

Answer 27

refers to the process by which the forces of demand and supply interact to determine the equilibrium price and quantity of goods and services in a market. it is a self regulating system that allocates resources efficiently without the need for central planning.

It ensures convergence towards equilibrium.

Question 28

Price signals of the Market Mechanism

Answer 28

1. A rising price signals producers to increase supply and consumers to reduce demand
2. A falling price signals producers to reduce supply and consumers to increase demand

Question 29

Consumer surplus

Answer 29

the difference between the maximum price consumers are willing to pay and how much they actually end up paying

Question 30

Producer surplus

Answer 30

the difference between the minimum price at which sellers are prepared to sell and how much they actually end up receiving

Question 31

Society’s welfare

Answer 31

refers to the overall wellbeing and quality of life of individuals within a society encompassing both material and non-material aspects. It is the summation of both consumer and producer surplus

Question 32

Advantages of a free market

Answer 32

1. Society’s welfare is at its greatest - resources are allocated efficiently and hence, both CS and PS are maximized
2. Signaling function - higher prices for producers signal increased demand prompting them to supply more, while for consumers it signals scarcity, encouraging them to consume less
3. Incentive function - higher prices discourage consumption and incentivizes producers to supply more.
4. Rationing function - ensures that scarce resources are distributed based on consumer’s willingness to pay, helping allocate resources efficiently in situations of limited supply

Question 33

Disadvantages of a free market

Answer 33

1. Inequality - wealth and income gaps can widen, as the system rewards those who own resources or have skills in demand
2. Market failures - externalities and public goods
3. Short term focus - businesses focus on immediate profits over long term sustainability