Chapter Two

4 Key assumptions of the supply and demand model

1) Supply and demand are in a single market 2) All goods in the market are identical 3) All goods sell for the same price and everyone in the market has the same information 4) There are many consumer and many producers in the market

What is the difference between a change in quantity demanded and a change in demand?

A change in quantity demanded is a movement along the demand curve that occurs because of a change in the good's own price, while a change in demand reflects a shift of the entire demand curve caused by a change in a determinant of demand other than the good's price.

What is the difference between a change in quantity supplied and a change in supply?

A change in quantity supplied is a movement along the supply curve that occurs because of a change in the good's own price, while a change in supply reflects a shift of the entire supply curve caused by a change in a determinant of supply other than the good's price.

In what direction will price and quantity move as a result of a demand shift?

A demand shift causes equilibrium price and quantity to change in the same direction. More specifically, an outward shift in demand increases both price and quantity, while an inward shift in demand decreases price and quantity.

In what direction will price and quantity move as a result of a supply shift?

A supply shift causes equilibrium price and quantity to change in opposite directions. More specifically, an outward shift in supply decreases price but increases quantity; an inward shift in supply increases price but decreases quantity.

Complements & Substitutes

Compliment: A good used in combintaiton with another good Substitute: A good used in place of another good.

What happens to equilibrium price when supply and demand shift in the same direction? What happens to equilibrium quantity in the same situation?

If supply and demand both increase, quantity increases; if both supply and demand decrease, quantity decreases. The effect on price is unknown: It depends on the relative magnitudes of the supply and demand shifts.

What form do inverse supply and demand equations take? Why do economists often represent supply and demand using the inverse equations?

The inverse demand curve expresses the price of a product as a function of quantity demanded. The inverse supply curve expresses the price of a product as a function of quantity supplied. Expressing price as a function of quantity makes the demand and supply choke prices more explicit.

We learned that economists have special terms for elasticities of particular magnitudes. Name the magnitudes for the following: inelastic, elastic, unit elastic, perfectly elastic, and perfectly inelastic.

The magnitude of each is as follows: inelastic E < 1, elastic E > 1, unit-elastic E = 1, perfectly elastic E = 0, and perfectly inelastic E = ∞.

Define market equilibrium. What is true of the quantity supplied and demanded at the market equilibrium?

The market equilibrium occurs at the intersection of supply and demand curves for a good. At equilibrium, the quantity supplied by producers equals the quantity demanded by consumers

Using the concept of cross-price elasticity of demand, describe substitutes and complements.

The price elasticity of demand reveals whether total expenditures will increase or decrease with prices. In particular, total expenditures increase with prices if demand is inelastic, decrease with prices if demand is elastic, and stay constant if demand is unit-elastic.

What is the difference between an elasticity and slope?

The slope of a supply or demand curve relates changes in the level of prices to changes in the level of quantity demanded or supplied. Elasticity represents the responsiveness of quantities to prices. More specifically, we express elasticity as the percentage change in quantity for a given percentage change in price.

Why is the supply curve upward-sloping?

The upward slope of the supply curve reflects the fact that holding all else equal, producers supply more of a good as its price increases.

Using the concept of income elasticity of demand, describe normal, luxury, and inferior goods.

Total expenditure and total revenue are both equal to price times quantity

What simplifying assumption do we make to build a demand curve? Why is the demand curve downward-sloping?

We assume that there is no change in any other factors that may also affect how much of a good a consumer buys. The downward slope reflects the fact that consumers demand less of a good as its price increases.

Why is the direction of change of either price or quantity unknown when both supply and demand shift?

When both supply and demand shift, the direction of change in either quantity or price is determined by the relative magnitudes and directions of the shifts.

What happens when price is below the equilibrium price? Why?

When the market price is too low, there is excess demand (shortage) for a good because consumers demand more of the good than producers are willing to supply at the relatively low price.