Download Supply and Demand: Principles of Economics in Context and more Exercises Economics in PDF only on Docsity!
CHAPTER 4
SUPPLY AND DEMAND
Principles of Economics in Context (Goodwin et al.)
Chapter Overview
In this chapter, you’ll find the basics of supply and demand analysis. The chapter explains how the curves are constructed, their slopes, and how they interact to produce market equilibrium. As you work through this chapter, you will start learning how to manipulate supply and demand curves as a way to analyze the relationships among prices, volume of production, and other factors. You will learn about the various factors that can shift a supply or demand curve up or down, the concepts of equilibrium price and quantity, and market adjustment.
Objectives
After reading and reviewing this chapter, you should be able to:
- Interpret supply and demand curves.
- Understand the difference between a change in supply (demand) and a change in the quantity supplied (demanded).
- List the non-price determinants of supply by businesses and demand by households.
- Explain how price adjusts due to changes in supply and demand.
- Understand topics of market analysis including scarcity, shortage, inadequacy, and equity.
- Explain the difference between accuracy and precision.
Key Term Review
demand supply market price market quantity sold positive (or direct) relationship individual supply market (or aggregate) supply supply schedule supply curve change in quantity supplied ceteris paribus change in supply nonprice determinants of supply demand schedule demand curve
negative (or inverse) relationship market (or aggregate) demand individual demand change in the quantity demanded change in demand nonprice determinants of demand substitute good complementary good surplus shortage market equilibrium theory of market adjustment market disequilibrium markup (or cost-plus) pricing market value
social value inadequacy
precise accurate
Active Review
Fill in the Blank
- A curve indicating the quantities that buyers are willing to purchase at various prices is known as a(n) ________________ curve.
- Mark would like to buy a new car for $20,000. However, he doesn't have any savings and he doesn't qualify for a loan. Thus, his desire for a car does not translate into ___________________ demand.
- Tabitha needs furniture for her room. She is deciding between a medium-sized couch and a large armchair. Either the couch or the armchair could fulfill her need for sitting space in the room. The couch and the armchair can be referred to as ___________________ goods.
- When people eat french fries, they like to put ketchup on them. Due to an increase in the price of french fries, total sales of french fries decrease. At the same time, ketchup sales also decrease. This phenomenon can be explained by noting that french fries and ketchup are ____________________ goods.
- Surplus and shortage are both instances of ____________________.
- In general, in a basic model showing supply and demand, if the supply curve shifts to the right, equilibrium price will _______________ and equilibrium quantity supplied will __________________.
True or False
- The price of limes could be a nonprice determinant of the supply of lemons.
- The demand curve for a good shows the same information as the demand schedule.
- Tastes and preferences act as nonprice determinants of demand.
- In general, an increase in demand tends to increase equilibrium price and decrease equilibrium quantity.
- If both supply and demand increase, the price of the good will also increase.
- If demand increases and supply decreases, the price of the good will increase.
- The more precise a model is, the more likely it is to be accurate.
Problems
- For the following questions, refer to the graph shown above.
a. Label the equilibrium point as E 1 , the equilibrium quantity as Q 1 , and the equilibrium price as P 1.
b. Show how the supply curve will change if car manufacturers achieve a technological breakthrough that allows them to produce cars more cheaply.
c. If the price stayed at P 1 , would a surplus or a shortage result from the technological breakthrough described in part (b)? Answer in words, and show on the graph.
d. Assuming market forces work quickly, show the new equilibrium price to which the market will adjust. Label this point as E 2. Label the new equilibrium quantity as Q 2 , and the new equilibrium price as P 2.
e. In words, summarize the information that you have shown in your adjustments to the graph in parts (a) through (d).
Price of Cars
Quantity of Cars
S 1
D 1
- The graph above shows supply and demand for hardcover English dictionaries. Suppose that a new dictionary resource is created on the Internet, decreasing people’s interest in buying large dictionaries in book form. For the questions below, state the answer in words and, where relevant, diagram your answer.
a. What happens to the demand curve for hardcover dictionaries, as a result of this Internet innovation? (Answer in words and diagram.)
b. What happens to the supply curve as a result of the Internet innovation? (Answer in words and diagram.)
c. What happens to the price of hardcover dictionaries as a result of the innovation? Show the new price level on the graph you drew for part (b).
d. Suggest one or more factors that could prevent this market from adjusting to equilibrium.
Price of Hardcover Dictionaries
Quantity of Hardcover Dictionaries
S
D
Self Test
- Suppose when the price of shirts increases from $20 to $25, the quantity supplied increases. This change is best described as …
a. movement along a supply curve. b. a change in supply. c. movement along a demand curve. d. a change in demand. e. none of the above.
- Which one of the following statements is false?
a. Demand curves tend to slope downward. b. The relationship between price and quantity demanded is generally positive. c. The relationship between price and quantity supplied is generally direct. d. At equilibrium, the quantity demanded equals the quantity supplied. e. A shortage occurs when the quantity demanded exceeds the quantity supplied.
Questions 3 to 5 refer to the following graph:
- Based on the figure above, how many apartment owners would be willing to sell their apartments for $91,000?
a. None b. One c. Two d. Six e. Ten
The Supply Curve for Apartments
89
90
91
92
93
94
95
96
97
98
99
100
101
0 1 2 3 4 5 6 7 8 9 10 11
S
Price of Apartments (in $1000s)
Quantity of Apartments
- In the graph above, up to ten apartments may be available for sale. Suppose that ten more apartment owners enter the market, for a total of twenty available apartments. These new entrants into the market would be willing to sell their apartments for any price above $90,000. Which of the following statements accurately describes the resulting change in the supply curve?
a. The supply curve shifts upward. b. The supply curve shifts to the right. c. The supply curve shifts to the left. d. The supply curve becomes longer. e. The supply curve can no longer be represented by a straight line.
- In the situation described in Question #4, how many apartment owners would be willing to sell their apartments for $91,000?
a. None b. One c. Two d. Ten e. Eleven
- Which of the following statements is true, regarding the supply of a particular good, and that good’s own price?
a. A price increase shifts the supply curve to the right. b. A price decrease shifts the supply curve to the right. c. A price increase shifts the supply curve downward. d. A price change alone does not shift the supply curve. e. A price change is the only way to shift the supply curve.
Question #7 refers to the following graph.
0
20
40
60
80
100
0 10 20 30 40 50
S 2 S 1
Quantity of Rugs
(Number per month)
Price of Rugs ($)
- Suppose the number of engineers graduating from college increases at the same time as the demand for engineers increases. Which one of the following is true?
a. The number of engineers employed will increase, and engineer wages will increase. b. The number of engineers employed will increase, and engineer wages will decrease. c. The number of engineers employed will increase, but the effect on engineer wages is ambiguous. d. Engineer wages will increase, but the effect of the number of engineers employed is ambiguous. e. The effect on both engineer wages and the number of engineers employed is ambiguous.
Question #12 refers to the following graph.
- Assume that sofas and arm chairs are substitute goods. The graph shown above illustrates the demand curve for sofas. Which of the following events could have triggered the shift in demand from D 1 to D 2 , as shown above?
a. The price of sofas increased. b. The price of armchairs increased. c. The price of labor for making sofas increased. d. The price of sofas decreased. e. The price of armchairs decreased.
20
25
30
35
40
45
50
0 5 10 15 20 25
D 1 Price of Sofas ($) D 2
Quantity of Sofas
- A bike shop in a small town has received a shipment of 10 new bicycles. The shop offers the bikes for sale at a price of $300 each. At this price, however, there are only two people in town who are willing to buy a bicycle. This situation can be described as
a. disequilibrium b. shortage c. surplus d. equilibrium e. both a and c are correct
Questions 14 to 16 refer to the graph below.
- When the price of cars is $5000, which of the following terms is not an accurate description of the situation?
a. Quantity demanded exceeds quantity supplied. b. A shortage exists. c. The market is in disequilibrium. d. Fewer than five cars are available for sale. e. The market is in equilibrium.
- Beginning from the price of $5000, which of the following events would be predicted by the theory of market adjustment?
a. Some buyers who are willing to pay more will bid the price of cars up. b. The market will remain in disequilibrium. c. Prices will fall. d. All buyers will remain in the market. e. The supply and demand curves will shift to achieve equilibrium.
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
0 1 2 3 4 5 6 7 8 9 10 Quantity of Cars
S
D
- When the supply of a good increases, what happens to equilibrium price and quantity?
a. They both increase b. They both decrease c. Price increases, quantity decreases d. Price decreases, quantity increases e. The effect is ambiguous
Answers to Active Review Questions
- demand
- effective
- substitute
- complementary
- disequilibrium
- decrease, increase
- True. For example, if limes command a high price, lemon producers might switch to lime production, thus decreasing the total supply of lemons available.
- True.
- True.
- False. In general, an increase in demand tends to increase both equilibrium price and equilibrium quantity.
- False. The impact of these changes on equilibrium price is ambiguous.
- True.
- False. The more precise a model is, the less likely it is to be accurate.
- Market supply is 200.
- Available technology of production; resource prices; number of producers; producer expectations about future prices and technology; prices of related goods and services; physical supply of a natural resource.
- The demand curve slopes downward because in general, the higher the price of the good, the fewer people will want to buy it.
- Occasionally, people will want more of a good if it is sold as a "prestige" good at a high price. This phenomenon might sometimes be observed with specialty foods, clothes, or cars.
- "Change in quantity demanded" refers to movement along the demand curve. For example, if the price of apples rises, all other things being equal, people will buy fewer apples; thus, the quantity demanded will decrease. A "change in demand" refers to a situation in which the entire demand curve shifts. For example, if a large number of new people move into your neighborhood, there will be a larger pool of people interested in buying apples at the local grocery store.
- One example is the shortage of nursing staff in health care settings, a shortage that has existed for decades. You may come up with other real-life or hypothetical examples. For example, adjustment to equilibrium might take a long time in a
housing market; sellers might keep prices high for a period of time, hoping to find takers, even though few people are willing to purchase homes at those prices.
- No, this market is not in equilibrium; there is a shortage of movie tickets.
Answers to Problems
1.a.
- b.
- c. The shift in the supply curve creates a temporary surplus.
Price of Cars
Quantity of Cars
S 1
D 1
E 1
Q 1
P 1
Price of Cars
Quantity of Cars
S 2
D 1
E 1
S 1
Price of Cars
Quantity of Cars
S 2
D 1
E 1
S 1
Surplus
- The equilibrium price could rise as a result of the supply curve shifting to the left (i.e. a decrease in supply), or as a result of the demand curve shifting to the right (i.e. an increase in demand).
- a.. The demand curve shifts to the right, as shown below.
- b.
- c.
Quantity of deck chairs
Price of deck chairs
S
D 1
D 2
Quantity of deck chairs
Price of deck chairs
S
D 1
D 2 shortage
Quantity of deck chairs
Price of deck chairs
S
D 1
D 2 shortage
E 1
E 2
- a. The supply curve shifts to the left, leading to a higher equilibrium price and lower equilibrium quantity.
- b. The demand curve shifts to the left, leading to a lower equilibrium price and lower equilibrium quantity.
Answers to Self Test Questions
- a 11. c
- b 12. e
- b 13. e
- b 14. e
- e 15. a
- d 16. d
- a 17. b
- e 18. a
- a 19. d
- e 20. d
Quantity of deck chairs
Price of deck chairs
S 1
E 1
D 1
S 2
E 2
Quantity of deck chairs
Price of deck chairs
S 1
E 1
D 2 D 1
E 2
