Macro Quiz 2

State the law of supply.

quantity supplied rises as price increases or, alternatively, that quantity supplied falls as price decreases.

Why is price directly related to quantity supplied?

Price is directly related to quantity supplied because, as price rises, people and firms rearrange their activities to supply more of that good in order to take advantage of the higher price.

Mary has just stated that normally, as price rises, supply will increase. Her teacher grimaces. Why?

Saying that supply increases means that the curve has shifted to the right, which is not the result of a price change. The correct statement is that, normally, as price rises, the quantity supplied increases, other things constant.

Start by drawing a supply and demand equilibrium situation. Using your diagram, demonstrate graphically and explain verbally the impact of a decrease in supply on equilibrium price and quantity.

The initial equilibrium is point A. A decrease in supply is shown as the shift from S0 to S1. The new equilibrium is point B with a higher price level (P1 > P0) and a lower quantity exchanged (Q1 < Q0).

Demonstrate graphically and explain the difference between a decrease in the quantity supplied and a decrease in supply. Describe what might have caused each to occur

A decrease in the quantity supplied refers to moving downward along a supply curve as illustrated by the movement from point B to point A in the diagram below. This movement is caused by a decrease in the price of the item being supplied. A decrease in supply refers to a leftward shift of the entire supply curve (from S0 to S1) as illustrated by the movement from point A to point B at price P0 in the diagram below. This movement is the result of a change in one of the shift factors. For example, a tax on the sale of a good levied on sellers will cause the supply curve to shift leftward.

It has just been reported that eating red meat is bad for your health. Using supply and demand curves, demonstrate the report's likely effect on the equilibrium price and quantity of steak sold in the market.

In the accompanying graph, the initial demand curve is shown as D0. Before the report, the market is in initial equilibrium, where the market price (equilibrium price) is P0 and market quantity (equilibrium quantity) is Q0. The equilibrium is determined by the interaction between the supply curve and the demand curve D0. It means that suppliers supply Q0 and consumers demand exactly the same amount. And the two parties agree on the price P0 so the market is in equilibrium and the price P0 is sustainable. After the report, people may not like red meat that much anymore, so the demand curve has shifted to the left, causing a decrease in aggregate demand. The new demand curve is shown as D1 in the accompanying graph. The interaction between supply and demand will push the market to a new equilibrium where the equilibrium price is P1 and the equilibrium quantity Q1. So from the graph, we can make a forecast that the report will cause a decrease in the market price and the market quantity.

Start by drawing a supply and demand equilibrium situation. Using your diagram, demonstrate graphically and explain verbally the impact of a decrease in demand and an increase in supply on equilibrium price and quantity.

The initial equilibrium is point A which is determined by D0 and S0. A decrease in demand is shown as the shift from D0 to D1. The increase in supply is shown as the shift from S0 to S1. The new equilibrium is point B with a lower price. The change in the quantity will depend.

Start by drawing a supply and demand equilibrium situation. Using your diagram, demonstrate graphically and explain verbally the impact of an increase in demand and an increase in supply on equilibrium price and quantity.

The initial equilibrium is point A. An increase in demand is shown as the shift from D0 to D1. The increase in supply is shown as the shift from S0 to S1. The new equilibrium is point B with a greater quantity exchanged (Q1 > Q0) but no change in the price level. The actual change in the price level will depend.

Start by drawing a supply and demand equilibrium situation. Using your diagram, demonstrate graphically and explain verbally the impact of an increase in demand on equilibrium price and quantity.

The initial equilibrium is point A. An increase in demand is shown as the shift from D0 to D1. The new equilibrium is point B with a higher price level (P1 > P0) and a greater quantity exchanged (Q1 > Q0).

Explain the error in the following statement: "For the past 10 years, the prices of automobiles have been rising and each year people have purchased more autos. Price and quantity demanded are positively related and the economists' law of demand is incorrect."

The law of demand states that price and quantity demanded are inversely related, other things constant. The statement failed to incorporate the last part of the definition—other things constant. The reason why more cars were purchased is that the demand for cars has increased in the past 10 years. In other words, the demand curve shifts to the right, causing the equilibrium price to be higher. It is not a movement along the demand curve anymore. The increase in demand is basically due to the rise in population, rise in income, rise in the value of time, etc. In the graph, before the increase in demand, the market price is P0 and quantity is Q0. After the increase in demand, the equilibrium price becomes P1 and quantity becomes Q1. Both price and quantity are higher than the initial equilibrium level.

List four shift factors of supply and explain how each affects supply.

the price of inputs, technological advances, changes in expectations, and taxes and subsidies. As the price of inputs increase, the supply curve shifts to the left (supply decreases). As technological advances are made that reduce the cost of production, the supply curve shifts to the right. If a supplier expects the price of her good to rise, she may decrease supply now to save and sell later. Other expectational effects are also possible. Taxes paid by suppliers shift the supply curve to the left. Subsidies given to producers shift the supply curve to the right.