Unit 8: Supply & Demand

Question 1

Supply Curve

Answer 1

total quantity that all firms together would produce at any given price

represent willingness to accept of sellers

sellers may have different reservation prices

at equilibrium (market-clearing) price, supply = demand

any other prices aren’t at Nash equilibrium

assumes products are identical so buyers would be willing to buy from any seller

Question 2

Price taking firms

Answer 2

cannot benefit from choosing a different price from the market price and thus cannot influence the market price

firms choose quantity not price

demand curve (feasible set) is completely flat

Maximise profits when MC=MR, with MR=P (slope of isoprofit = 0) so marginal revenue = market price

so firm’s supply curve = marginal cost curve

Question 3

Market supply curve

Answer 3

the total amount produced by all firms at each price

if firms have identical cost functions, market supply curve = market marginal cost curve

Question 4

competitive equilibrium

Answer 4

all buyers and sellers are price-takers

at the prevailing market price, supply = demand

all gains from trade are exploited (no DWL)

is Pareto efficient assuming:

• participants are price takers
• contracts are complete
• transaction only affects buyers & sellers

Question 5

Fairness in competitive equilibrium

Answer 5

the distribution of total surplus depends on the elasticities of demand & supply (share of total surplus inversely related to elasticity)

Question 6

Factors that affect equilibrium

Answer 6

Changes in demand: fads increase consumer’s willingness to pay so demand up

changes in supply: product innovation reduces cost
supply curve shifts down as less cost to produce supply

Question 7

Change in supply - Market entry

Answer 7

supply curve can shift due to market entry/exit

if existing firms are earning economic rents and costs of entry aren’t high other firms may enter the market

Question 8

Taxes

Answer 8

Taxes on suppliers shift the supply curve as price is higher at each quantity

taxes lower surplus as both consumer and producer surplus lowered

see graph for visual

Question 9

Welfare effects of taxes

Answer 9

tax incidence depends on the relative elasticity of consumers and producers. The less elastic group bears more of the tax burden

taxes can still raise welfare if governments use tax revenue to provide beneficial goods/services

e.g in 2011 Denmark set tax on saturated fat equivalent to 22% of butter price - consumption of butter and related products fell by 15-20%

eventually removed tax as was an administrative burden to collect

Question 10

Perfect competition

Answer 10

a perfectly competitive market has:

• the good or service being exchanged is homogeneous
• very large number of potential buyers and sellers
• buyers and sellers all act independently of one another
• price information easily available to buyers and sellers

Question 11

Law of one price

Answer 11

all transactions take place at a single price

• at that price the market clears (supply=demand)
• buyers and sellers are all price-takers
• all potential gains from trade are realised

hard to find perfect competition as even when consumers easily check prices (online shopping) prices of the same product differ

Question 12

Price setters (monopoly)

Answer 12

• MC less than price
• deadweight losses (Pareto inefficient)
• owners receive economic rents in long and short run
• firms advertise their unique product
• firms invest in R&D and seek to prevent copying

Question 13

Price-takers (perfect competition)

Answer 13

• MC = price
• No deadweight losses (can be Pareto efficient)
• no economics rents in long run
• little advertising expenditure
• little incentive for innovation