Econ 206 Topic 14

(a) What can cause a market demand curve to shift? (b) What is the distinction between a shift of the demand curve and a movement along the demand curve?

(a) Any of the determinants of demand except for the price of X. (b) A shift in the demand curve occurs when one of the determinants of the demand for X, other than its price, changes. Because the demand curve shows the relationship between the price of X and the quantity demanded of X, ceteris paribus - the only variables in the demand curve diagram are PX and Qd X - then we must redraw the demand curve to take account of the change in the non-price of X determinant; the demand curve shifts to the right or left. But a change in the price of X causes a movement along the demand curve because we are simply showing the effect of the change in the variable on the vertical axis, PX, on the variable on the horizontal axis, Qd X.

(a) What can cause the market equilibrium to change? (b) Can the equilibrium price and quantity rise at the same time without violating the "law of demand"?

(a) Any violation of the ceteris paribus assumption, that is any change in a demand or supply shifter. (b) If something causes the demand for X to increase (D to D′), for example an increase in the price of a substitute for X, then the demand curve will shift to the right along the positively sloped supply curve and both Pe and Qe will increase. The effect of the excess demand at Pe is to raise the price of X, which reduces the quantity demanded along the original demand curve (A to B). However, the increase in demand (B to C) leads to a larger quantity being demanded at the new equilibrium (Qe to Qe′). There is no violation of the so called "law of demand" which refers to movements along the demand curve, caused by a change in the price of X, ceteris paribus.

(a) Is the supply curve upward sloping or downward sloping? (b) What can cause a market supply curve to shift? (c) What is the distinction between a shift of the supply curve and a movement along the supply curve?

(a) The SC is the MC curve of the perfectly competitive firm and it is positively sloped because an increase in output must add to the firm's variable costs and the firm will only bear those extra costs if it is compensated by an increase in price. (b) Any determinant of supply except the price of the good or service, PX. (c) A movement along the supply curve is the result of a change in the price of X, ceteris paribus. But if any other supply side variable changes then we have to redraw the supply curve to take account of that change because none of the supply determinants are shown in the supply curve diagram except for PX. If the only thing that has changed is the price of X then that means that we move from one point on the supply curve to another point on the supply curve.

(a) Explain how supply and demand interact to determine market equilibrium. (b) What happens to the price of a good if there is a shortage of the good? (c) What happens to the price of a good if there is a surplus of the good?

(a) The demand side of the market reflects the behavior of buyers and the supply side of the market reflects the behavior of sellers. The interaction between buyers and sellers brings about market equilibrium. (b) The price increases as unsatisfied buyers bid up the price. (c) The price decreases as firms that are unable to sell their profit maximizing output at the going price, bid that price down.

(a) What is the "law of demand"? (b) What does the "law of demand" imply in terms of the slope of the demand curve? (c) Explain the theoretical basis for the "law of demand" in terms of the substitution and income effects.(c) An increase in the price of a good or service makes it relatively more expensive, ceteris paribus, since no other price will have increased (the SE). The increase in price also means that the consumer's purchasing power has decreased - at the higher price you cannot buy as many X as before the price change. This is equivalent to a reduction in your income (the IE). With a normal good this will cause the consumer to spend less on X.

(a) The so called "law of demand" claims that there is an inverse relationship between the price of a good and the quantity demanded of the good; that the price and quantity demanded move in opposite directions. (b) If the so called "law of demand" holds then the demand curve will be negatively sloped.

P0=WTA (willingness to accept)

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Supply=MC

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assumptions of S&D

-buyers buy less if relative price of X increases and buy more if price decreases. Inverse for demand. -perishable goods/services only

Assumption of supply curve

-firms are profit maximizers (denonated by pi). P=total revenue-total costs -firms are price taking perfectly competitive firms -cosumers are price takers (no one influences price) -same access to information -firms are operating in the short run, cannot change the amnt of capital employed (fixed input) Therefore, face increasing MC's, TC rises as output rises -in order to persuade firms to increase output, buyers have to offer higher prices to cover the firm's increases MC

Determinants of Supply/Shifters

1. Price of X (does not shift, only move along) 2 Prices of Inputs (wages, salaries, etc) 3. Interest owed to capital- rents 4. Technology 5. Weather 6. Govt Regulation 7. # of sellers/firms

Determinants of Demand/Shifters

1. The price of X (does not shift, only move along) 2. Prices of the substitutes 3. Prices of the complements 4. Income 5. Tastes/preferences 6. # of buyers

Ambiguous effects of income and substitution

1. X is a normal good/service: the two effects reinforce each other 2. X is an inferior good and service (has a more preferred, more expensive substitute) -the income effect is smaller than subst.=demand has neg slope -income effect is larger than subst=demand has positive slope -effects cancel, demand is vertical line (Giffen Good)

Giffen Good

A good with a vertical demand curve, willing to pay at any price. Yet there is a maximum income amnt.

Real markets aren't perfect

If they were then they would self equilibrate. Social optimum. But they aren't.

Common Error!:

Increase in demand for X must be an increase in supply of X. Wrong! Increase in demand for X causes Px to increase as it moves along the stationary supply curve. Increase in Px causes the quantity supplied of X to increase. Change in QUANTITY supplied, not change in supply of X.

Movements vs Shifts along the S&D curve:

Movement: associated with a change in the price of X, ceteris paribus. "a change in the quantity demanded/supplied of X" Shift: is the consequence of something OTHER than price of X changing. "a change or shift in the demand/supply curve"

What determines the allocation of resources in a market economy?

Prices

What determines prices?

Supply and demand

The demand curve for X shows:

The maximum price the consumer will pay for each unit of X (WTP).

What is the distinction between nominal prices and relative prices?

The nominal price is simply the money price, the number of dollars that you have to pay to obtain the good. The relative price is a price ratio or rate of exchange or the tradeoff between the two goods or services. Economists usually mean the ratio of the price of X to the price of Y (PX/PY) or, sometimes, the ratio of the good's price to the general price level, PX/P where P is the average price level.

The demand curve for X shows: 2

The relationship between the price of X and the quantity demanded of X.

Excess supply

When there is excess supply of X, the price will be bid down. Quantity supplied is larger than quantity demanded

Assume that tortilla chips and salsa are complements. When the price of tortilla chips decreases (ceteris paribus): a) The demand for salsa increases. b) The demand for salsa decreases. c) The supply of tortilla chips shifts to the right. d) There is no effect on the market for salsa. e) There is not enough information to answer the question.

a

If Y is a substitute for X then an increase in the price of Y will: a) Cause an increase in the demand for X. b) Cause a decrease in the demand for X. c) Cause an increase in the demand for Y. d) Cause a decrease in the demand for Y. e) Have no effect on the demand for X if X is an inferior good or service.

a

In 2013 the price of wine fell rose and the equilibrium quantity of wine transacted also fell. What might explain that outcome? a) A decrease in the demand for wine. b) A decrease in the supply of wine. c) An increase in the demand for wine. d) An increase in the supply of wine. e) A decrease in the demand for beer.

a

The demand curve for peanuts shifts to the right as consumers' incomes rise, ceteris paribus. From this, we can conclude that a) Peanuts are a normal good. b) Peanuts are an inferior good. c) Peanuts are a complementary good. d) Peanuts are a substitute good. e) None of the above

a

The supply curve for X has a positive slope because: a) The MC increases in the short run because of diminishing returns to the variable input. b) The substitution effect always causes quantity of X to move in the same direction as the price of X. c) The substitution effect for a normal X always causes the quantity supplied of X to increase when the price of X increases. d) The income effect is always, in practice, smaller than the substitution effect (ignoring the minus sign). e) The income effect is always, in practice, larger than the substitution effect (ignoring the minus sign).

a

When the price of a normal good rises (ceteris paribus): a) The substitution effect and the income effect cause the quantity demanded to move in the same direction. b) The substitution effect and the income effect cause the quantity demanded to move in opposite directions. c) The substitution effect causes the quantity demanded to increase. d) The income effect causes the quantity demanded to increase. e) The quantity demanded will increase.

a

substitution effect

a price increase will lead to an increase in the quantity demanded

Consider the market for bottled water. Soda is a substitute for bottled water. If the price of soda increases (ceteris paribus), which one of the following might be an outcome? a) The demand curve for soda will shift to the left. b) The demand curve for bottled water will shift to the right. c) The demand curve for bottled water will shift to the left. d) The demand curve for soda will shift to the right. e) Both a and b.

b

If Y is an input in the production of X then an increase in the price of Y will: a) Cause an increase in the supply of X. b) Cause a decrease in the supply of X. c) Cause an increase in the quantity supplied of Y. d) Cause an increase in the demand for Y. e) Have no effect on the supply of X in the short run because the firm cannot adjust the amount of capital it can use.

b

Supply shifters shift supply curves primarily because they change: a) The competitiveness of the firms in the industry. b) The profitability of firms. c) The size of markets. d) The size of industries. e) The incomes of buyers.

b

The demand shifters are: a) The price of X, the prices of substitutes, the prices of complements, income, preferences, and the number of buyers. b) The price of X, the prices of inputs, technology, "weather", government activity, and the number of sellers. c) The price of X, the prices of substitutes, technology, "weather", government activity, and the number of sellers. d) The prices substitutes, the prices of complements, income, tastes, and the number of buyers. e) The price of X, the prices of inputs, technology, "weather", and government activity.

b

2 types of economic agents in S&D model

buyers (individuals/households): maximize satisfaction, have a given income sellers (firms): maximize profits, have given technology/prices

Hops are used to produce beer. If the price of hops decreases (ceteris paribus): a) The demand for beer increases. b) The demand for beer decreases. c) The supply of beer increases. d) The supply of beer decreases. e) None of the above is correct.

c

In 2008 the price of crude oil decreased and the quantity of crude oil bought and sold increased. It is therefore reasonable to deduce that in 2008: a) There was an increase in the demand for crude oil. b) There was a decrease in the demand for crude oil. c) There was an increase in the supply of crude oil. d) There was a decrease in the supply of crude oil. e) There was an increase in the demand for crude oil and a decrease in the supply of crude oil.

c

The market for X is in equilibrium if: a) The price of X is $5, the quantity bought is 100 units, the quantity sold is 100 units, and the quantity supplied is 150 units. b) The price of X is $3, the quantity bought is 50 units, the quantity sold is 50 units, and the quantity demanded is 150 units. c) The price of X is $4 and the quantity bought is 125 units, the quantity sold is 125 units, the quantity demanded is 125 units and the quantity supplied is 125 units. d) The firms supplying X can sell all of the units they can produce. e) The households buying X can buy all of the X they can consume.

c

The market for X is in equilibrium if: a) At each and every price everyone who needs to consume X can purchase X. b) At each and every price every firm that can produce X can sell X. c) The demand curve is downward sloping. d) The quantity demanded of X is equal to the quantity supplied of X. e) The MC of producing X is less than the MB of producing X so that firms are able to make profits rather than losses.

d

The equilibrium price in a market: a) Occurs when the supply and demand curves are parallel. b) Is the price at which there is only a small surplus. c) Is the price at which there is only a small shortage. d) Does not depend on supply or demand. e) Is the price at which the quantity demanded equals the quantity supplied.

e

The supply of oil increases, ceteris paribus, which causes a fall in the price of oil, which causes the supply of gasoline to increase, which causes the price of gasoline to fall, which causes an increase in the demand for automobiles. a) This statement is incorrect because it confuses a change in the demand for automobiles with a change in the quantity demanded of automobiles. b) This statement is incorrect because it confuses a change in the demand for oil with a change in the quantity demanded of oil. c) This statement is incorrect because it confuses a change in the supply of oil with a change in the quantity supplied of gasoline. d) The statement is incorrect because the increase in the supply of oil must be accompanied by an increase in the demand for oil. e) The statement is correct

e

Equilibrium

everyone who wished to buy can find a seller and every seller can find a buyer. A situation in which there are no forces driving the price up or down. Unless the ceteris paribus assumption is violated.

ceteris paribus

everything is held constant, aka everything else that might have an influence on the outcome of the price decrease

relative scarcity/shortage is associated w/: relative abundance:

increases in prices decreases in prices resources are reallocated to their more valuable uses and away from the less valuable ones, the changes in prices signal that reallocation will be advantageous to buyers and sellers

Quantity demanded of x:

is the amount that we will purchase at a certain price

real price

making comparisons over time intervals in which inflation occurs- takes inflation into account. "constant dollar" or deflated price

Define Market

organizational arrangements that bring buyers and sellers into contact so that they may trade to their mutual, but not necessarily equal, advantage

income effect

when the price falls, it's as if there is an increase in income

true cost or full cost

take into account all of the costs- implicit and explicit- of acquiring the goods and services

nominal/money price

the number of dollars you must sacrifice to purchase a unit of the good/service