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Universidad Carlos III de Madrid – Department of Economics
Principles of Economics - Course 2014-
Problem Set 2
Conceptual Questions
- What are the main features of a competitive market?
There are many buyers and sellers of a homogeneous good or service. No individual’s actions have a noticeable effect on the price at which the good or service is sold.
- (^) How would you define the demand curve and what is the Law of Demand?
Demand curve is the graphical representation of the demand schedule; it shows how much of a good or service consumers want to buy at any given price. Law of Demand: A higher a price for a good, other things equal, leads people to demand smaller quantities of that good.
- What is the difference between a movement along the demand curve and a shift of the demand curve?
A movement along the demand curve is a change in the quantity demanded of a good that is the result of a change in that good’s price.
A shift of the demand curve is a change in the quantity demanded at any given price, represented by the change of the original demand curve to a new position, denoted by a new demand curve.
- Explain with the help of a graph the difference between change of demand and change of quantity demanded.
A shift of the demand curve is a change in the quantity demanded at any given price, represented by the change of the original demand curve to a new position, denoted by a new demand curve.
A movement along the demand curve is a change in the quantity demanded of a good that is the result of a change in that good’s price.
(Figure) On the left, a movement along the demand curve, on the right, a movement of the demand curve
- What causes a demand curve to shift?
a) Changes in the Prices of Related Goods
Substitutes: Two goods are substitutes if a fall in the price of one of the goods makes consumers less willing to buy the other good.
Complements: Two goods are complements if a fall in the price of one good makes people more willing to buy the other good.
b) Changes in Income
Normal Goods: When a rise in income increases the demand for a good – that good is a normal good.
Inferior Goods: When a rise in income decreases the demand for a good, it is an inferior good.
c) Changes in Tastes
d) Changes in Expectations
e) Changes in number of consumers
Problems
- Draw a demand curve for music downloads. What happens to this demand in each of the following scenarios? Why?
a. The price of iPods falls
X 2 = 7 – p
We can interpret the situation in terms of marginal utilities. For every level of price, the marginal utility of an orange for Helen is bigger than the marginal utility of an orange for Ken (and they are equal when price is zero). For any kind of change in the price, the marginal utility of Helen varies twice as much (in a positive way if price goes down, or in a negative if price goes up) than the marginal utility of Ken.
The inverse of the function of demand is the expression that indicates the price of the good as a function of the quantity demanded of that good
p = (14 - X1)/2 p = (7 – X2)
Because the function of demand has an inverse, we can represent p in both the horizontal axis and the vertical axis. By convention, we put the prices in the vertical axis and the quantities in the horizontal axis. This way is convenient because the demand function could be not well defined when prices are zero. Consquently we avoid the situation in which there is not an intersection between the vertical axis and the demand function. It does not make any difference if we put the price in the left hand side or in the right hand side of the equation.
Other Questions
- Does a change in the taste of the consumers generate a movement along the demand curve or a shift of the demand curve? Does a change in the price generate a movement along the demand curve or a shift of the demand curve?
The movements along the curve of demand are produced when there is a change in the price of the good, ceteris paribus. The demand curve will move if there is a change in one of the factors that affect the demand (without including the price of the good). An example of such a factor will be a change in the taste of consumers.
- The income of Popeye declines and for this reason he buys less spinach. Is the spinach an inferior or a normal good? What happened to the Popeye's demand curve of spinach?
The spinach is a normal good. A normal good is the one which demand moves in the same direction as the wealth. The demand curve of the spinach of Popeye will decrease, i.e., will move to the left.
- Explain each of the following statements:
a. When good weather starts in Boston, the hotel prices in the Caribbean go down.
Let’s assume that an increase in temperature in London reduce the amount of London citizens that will visit Malaga. Consequently, this is a factor that will move the demand curve of tourism of Malaga to the left, i.e., will decrease the demand curve.
b. When the gasoline price increases, more people commute by train.
Traveling by car and traveling by train are substitute’s goods. An increase of the price in oil implies an increase of the price of traveling by car, and consequently, and increase of the demand of traveling by train
- Consider the market of minivans and identify the determinants of the demand of such good, to determine whether the demand increases or decreases in each of the following scenarios:
a. People decide to have more babies.
The fact that the families are bigger is a positive factor for the demand of minivans, and consequently the demand curve of minivans will move to the right.
b. The price of “station wagons” goes up.
The station wagon is a substitute good of the minivan, so the demand of minivan will increase, the demand curve moves to the right
c. The stock-market crashes and the wealth of people decreases.
If we consider that the minivan is a normal good, a decrease in wealth will reduce the demand of minivans, and the demand curve will move to the left
- During the 90s technological advance reduced the price of both chips and computers. How does it affect the market of computers? How does it affect the market of software? And what can we say about the price of the typing machines?
