Macroeconomics Chapter 3
Explain the difference between a change in supply and a change in quantity supplied.
A change in supply(S) is represented by a shift in a supply curve. It can be caused by changes in non-price determinants of supply such as the cost of producing the product or the prices of related products. A change in the quantity supplied(Qd) is represented by a movement along a supply curve. It is caused by a change in the price of the good itself.
The following are some changes that may take place in the market for textbooks. For each of the following, indicate what will happen to either the demand for or the supply of textbooks by listing which curve is affected and then the terms: "shift right or "shift left". (a.) An increase in student enrollment at universities across the country. (b.) A decrease in the price of ink used to print textbooks. (c.) A drop in income (textbooks are a normal good). (d.) An improvement in the technology used to print textbooks. (e.) An increase in college tuition.
(a.) The demand curve will shift right. (b.) The supply curve will shift right. (c.) The demand curve will shift left. (d.) The supply curve will shift right. (e.) The demand curve will shift left.
The market for restaurant pizza in Chicago is currently in equilibrium at a price of $8 and 2,000 pizzas are sold each day. Explain what will happen to the equilibrium price and quantity of pizzas sold and why (which curve has changed) for each of the following situations: (a.) Delivery personnel form a labor union and secure a higher wage of $7.50 per hour (a large increase in their wage). (b.) Fast-food hamburger restaurants (Burger King & McDonalds) cut their prices in half.
(a.) The increase in wage will lead to an increase in the cost of producing pizzas. Therefore, the supply of pizza will decrease, causing the equilibrium price to rise and the equilibrium quantity to fall. (b.) The drop in price of fast-food hamburgers will lower the demand for pizza because pizza & hamburgers are substitute goods. Therefore, both the equilibrium price (Pe) and equilibrium quantity (Qe) will fall.
Explain the difference between a change in demand and a change in quantity demanded
A change in demand is represented by a shift in the demand curve and can be caused by changes in non-price determinants of demand such as income, preferences, or prices of related goods. A change in quantity demanded is represented by a movement along the demand curve and is caused by a change in the price of the good in question.
A free good is a good whose existence requires no opportunity cost to produce. How is this different from a good that is offered for a price of zero?
A good that is offered at a price of zero may not necessarily have been produced at zero opportunity cost. Often stores give away "free" products to get customers to try them but these products were probably not produced at zero opportunity costs. By that definition they are not free goods.
What relationship is shown by a supply curve?
A supply curve shows the relationship between price(P) and quantity supplied(Qs). Because price and quantity supplied are directly related, the supply curve is upward sloping.
Even though household have wide-ranging preferences, discuss some of the things that all households have in common including their constraints.
All households have limited income and all must pay in some way for the things they consume. They are also constrained by the availability of jobs, current wages, their own abilities, and their accumulated and inherited wealth.
Explain what an entrepreneur is and its function.
An entrepreneur is a person who organizes, manages, and assumes the risks of a firm, taking a new idea or a new product and turning it into a successful business.
Explain how an increase in the price of leather brought about by shift in tastes may lead to an increase in the supply of beef.
An increase in the price of leather will lead to an increase in the quantity of leather supplied(Qs). Thus, as ranchers raise more cattle (to increase the quantity of leather supplied), they will also have more beef to supply to the market.
Show graphically (in two separate graphs) the effects of an increase in the price of peanut butter on the demand for peanut butter and on the demand for jelly.
An increase in the price of peanut butter causes a decrease in the quantity of peanut butter demanded. This is shown by a movement along the demand curve for peanut butter from point A to point B. Since peanut butter and jelly are complements, an increase in the price of peanut butter will cause a decrease in the demand for jelly. This is shown by a shift in the demand curve for jelly to the left.
Show graphically the effect of an increase in the wage paid to autoworkers on the supply of new cars.
An increase in wage paid to autoworkers would increase the cost of producing a new car. Therefore, the supply of new cars will decrease.
SCENARIO 1: Consider the market for generic light beer, a product that only has "Light Beer" on its label. We know that demand for generic light beer falls when income increases, demand rises when the price of other beer increases, and that demand rises when the price of potato chips falls. Refer to Scenario 1. Graph and explain the effect on equilibrium price and quantity of an increase in income. What type of good is "Light Beer"?
As income increases, demand for generic light beer falls from D0 to D1 and the equilibrium price and quantity both fall. Generic light beer is an inferior good.
Refer to Scenario 1. Graph and explain the effect on equilibrium price(Pe) and quantity (Qe)of beer due to an increase in the price of potato chips. How are the goods related?
As the price of potato chips increases, the demand for generic light beer falls and the equilibrium price(Pe) and quantity(Qe) both fall. The goods are complements.
Graph and explain the effect on equilibrium price(Pe) and quantity(Qe) of an increase in the price of premium beer. How are the goods related?
As the price(P) for premium beer increases, the demand(D) for generic light beer rises, and the equilibrium price(Pe) and quantity(Qe) both rise. These goods are substitutes.
Assume that you are currently making $15,000 a year as a sales clerk in a department store. At the end of your senior year in college in May you get a job offer from a large accounting firm that won't start until late August of that same year but which pays $45,000 per year. What would you expect might happen to your demand for an automobile and new clothes immediately and why?
Because of the expectation of higher income in the future you will probably purchase a car and some new clothes to get ready for new job.
What is the difference between a demand schedule and a demand curve?
Both show quantity demand at a given price. The only difference is the form of the information. A demand schedule lists the price and quantity information in a table. A demand curve shows the same information using a graph.
When the price of compact disc players decreases, the demand for compact discs rises while the demand for cassette tapes decreases. What does this imply about the relationship between compact disc players, compact discs, and cassette tapes?
Compact disc players and compact discs must be complements. Compact disc players and cassette tapes must be substitutes.
In what ways can expectations change your demand for a product today?
Expectations about both future prices and future incomes may affect your demand for a product today. For example, if you expect the price of gasoline to rise tomorrow, you will want to fill up your car's gas tank today. Also, expectations about future incomes may affect purchases today. An individual who believes that he may soon be laid off from his job (and therefore see a drop in his income) will be unlikely to purchase a new car today.
List three characteristics of demand curves. Make sure to explain the shape of the curve and the meaning of the vertical and horizontal intercepts.
First, they are downward sloping. Second, they intersect the vertical axis because there will be a price above which quantity demanded will be zero. Last, they intersect the horizontal axis. Even at a price of zero, quantity demanded will be limited for a given period of time.
When the price of good X rises, the demand for good Y falls. Explain what this relationship implies about the two goods.
Goods X and Y must be complements. When the price of good X rises, the quantity of good X demanded will fall. If the demand for Y also falls, the two goods must be used together.
When the price of good X rises, the demand for good Y rises. Explain what this relationship implies about the two goods.
Goods X and Y must be substitutes. When the price of good X rises, the quantity of good Y demanded will rise.
Suppose the U.S. economy enters a recession and incomes fall. What will happen to the equilibrium prices and quantities of normal goods? Would your answer be the same if you were discussing inferior goods? Why or why not?
If incomes fall, the demand for normal goods will fall as well. This means that the demand curve will shift to the left, lowering both the equilibrium price and equilibrium quantity. The answer would be opposite if we were discussing inferior goods. A decrease in income raises the demand for inferior goods, leading to a higher equilibrium price and quantity.
Explain how price expectations can affect the supply of a product
If sellers expect the price of the product to rise in the future, they will want to hold onto their product and sell it at that time. Therefore, their current supply will fall. Likewise, if sellers expect the price of their product to fall in the future, they will want to sell as much of their product as possible today, increasing the supply.
The cost of steel used in the production of many of the exercise products increases.
Prices of home fitness equipment will rise, but the equilibrium quantity will fall.
What types of things are sold in input or factor markets? Who are the buyers and sellers in these markets?
Resources used to produce goods and services are sold in input markets. These include labor, capital, and land. In input markets, households are the sellers (suppliers) and firms are the buyers (demanders).
John's income has just increased by $10,000 per year. If Ramen noodles is an inferior good in John's opinion, what will happen to his demand for Ramen noodles?
Since Ramen noodles is an inferior good for John, his demand for ramen noodles will decrease when his income rises. Therefore, his demand curve will shift to the left.
List three things that can cause an increase in demand. Be specific.
Student responses will vary but may include: (1.) An increase in income (normal good). (2.) A decrease in income (inferior good). (3.) An increase in the price of a substitute good. (4.) A decrease in the price of a complementary good. (5.) A change in preferences (the product is more desirable than before).
What relationship is shown by a demand curve?
The demand curve shows the relationship between price and quantity demanded. Since price and quantity demanded are inversely related, The demand curve is downward sloping.
Some baseball parks have a "7th Inning Stretch" where beer, hotdogs and other food items are offered for sale at a lower price. What economic concept is being used by the baseball park to justify this practice? If it is successful at selling more food and drink with this practice why don't they lower prices at the beginning of the game?
The economic concept is the law of diminishing marginal utility. By the 7th inning most of the patrons have already had a bite to eat and something to drink. As they become close to satiated they are deriving less and less marginal utility. Therefore, their willingness to pay to consume more of these items falls.
Suppose there is news that indicates that gasoline supplies might suddenly become disrupted by a truckers' union strike. What would you expect would happen to the demand for gasoline in the present? How might consumers change their behavior and why? What impact would this news have on the price of gasoline immediately? Would it matter whether the news story was accurate?
The expectations of a gasoline supply disruption might get consumers to keep their tanks full at all times. This "tank topping" behavior would artificially increase the demand for gasoline and would cause a price hike very shortly. It would not matter whether the news story was accurate but rather whether people thought it was credible.
Define what a firm is and its role in the market.
The firm is an organization that transforms resources (inputs) into products (output). Firms are the primary producing units in a market economy.
Homebuilders will often pay the closing costs (title, insurance, etc.) of prospective homebuyers? Explain in terms of supply and demand what homebuilders are trying to do with this practice.
The homebuilders are simply trying to stimulate demand. By offering to pay prospective homebuyers' closing cost it is almost the equivalent of handing these buyers extra income. Their ability and willingness to pay has increased. It can bring buyers into the market who would able to afford to buy a home except for the obstacle of having to come up with the cash for closing costs.
Using graphs, explain the effect of an increase in the price of cheese on the supply of cheese and the supply of pizza
The increase in the price of cheese will cause an increase in the quantity of cheese supplied, which can be shown by a movement along the supply curve for cheese. Since an increase in the price of cheese will raise the cost of producing pizza, the supply of pizza will decrease. This is shown by a shift of the supply curve for pizza to the left.
List and describe three different input markets.
The labor market is where household members sell their labor services in exchange for wages. In capital markets, households supply funds for firms to purchase capital equipment. Land and other real property are exchanged in the land market.
Explain the law of demand. What does it imply about the shape of the demand curve?
The law of demand describes the inverse relationship between price(P) and quantity demanded (Qd). All else equal, as the price of a good rises, the quantity demanded of the good will fall. As the price of a good falls, the quantity demanded rises. This implies that the demand curve will be downward sloping.
Each year Apple Computers produces a new line of IPods with greater storage capacity and more features. Sales continue to soar even though the prices each year rise as well. Is this a refutation of the law of demand or is there something else going on here that doesn't meet the eye?
The law of demand states that there will be a inverse relationship between price and quantity demanded all other things being equal. In this case the good itself is no longer the same good. Its storage capacity and other features have simply drawn more customers.
Explain the law of diminishing marginal utility. How does it relate to the shape of the demand curve?
The law of diminishing marginal utility states that each additional unit of a good consumed provides less and less additional satisfaction. Therefore, the amount that a person will be willing to pay for a product will fall as more of the product is consumed. This is one reason why demand curves slope downward.
Explain the law of supply. What does the law of supply imply about the shape of the supply curve?
The law of supply describes the positive relationship between price(P) and quantity supplied(Qs). All else equal, as the price of a good rises, the quantity supplied of the good rises as well. As the price of a good falls, the quantity supplied falls. This implies that the supply curve will be upward sloping.
Newspaper machines and soda vending machines operate very differently. The latter is mechanical box. You place your four quarters in the machine and you open the door and low and behold there is a stack of newspapers at your disposal. Most people take one and close the door for the next patron to purchase his own copy. But notice that soda vending machines don't operate the same way. They are also mechanical but when the four quarters are inserted and a selection is made only one can of soda is available for the consumer to purchase. Explain in terms of marginal utility why these two machines are designed so differently?
The marginal utility of a second newspaper is most likely to be zero for most people. That is, the extra added satisfaction of acquiring a second newspaper is probably negligible. After all, it contains all of the same news as the first copy. However, the cans of cold beverage that remain in the soda machine still have positive marginal utility even though it may be less than the marginal utility of the first can. It pays for the vendor to design a machine that keeps the rest of the cans of soda away from those who might not be inclined to pay for the second can of soda.
Explain how the market demand curve can be derived. Does the law of demand apply to the market demand curve?
The market demand curve for a good can be found by summing the quantities demanded by all of the households buying in the market for that good. Since all individuals' demand curves are downward sloping (due to the law of demand), the market demand curve will also be downward sloping. Therefore, the law of demand does apply to the market demand curve as well.
Explain how the market supply curve is derived. Does the law of supply apply to the market supply curve?
The market supply curve for a good can be found by summing the quantities supplied by all of the firms selling in the market for that good. Since all firms' supply curves are upward sloping (due to the law of supply), the market supply curve will also be upward sloping. Therefore, the law of supply does apply to the market supply curve as well.
A supermarket manager discovers that his generic brand beans are disappearing off of his shelves faster than he can restock them and the premium brand beans are staying on the shelf going unsold. What can we probably say about the current prices of each of these products in relation to the market-clearing price?
The price for the generic brand beans is probably below the market-clearing price and should be raised. The price for the premium brand beans is probably above the market-clearing price and should be lowered.
Most goods and service that we enjoy are bought and sold in the market. However, leisure is something that we value but we do not buy it explicitly. What is the price of leisure? Explain what would happen to the amount of leisure that we would enjoy if the wage rate went up. Make sure to use the substitution and income effect to explain your answer and postulate whether leisure is a normal or inferior good. Why is the ultimate net effect not determinable by appealing to logic alone?
The price of leisure is the wage rate. When we enjoy leisure we are giving up wages that we could earn. If the wage rate went up there would be two possible effects. If leisure is a normal good the income effect would prompt us to consume more of it. At the same time there is an opposite force, which now makes work more attractive. The higher wage may prompt us to want to work more and we may substitute work for leisure. If leisure is an inferior good then the increased wage would prompt us to consume less leisure and more work. The substitution effect would still induce us to replace work for leisure. If leisure is a normal good the effect is ambiguous unless we know whether the income or substitution effect is stronger. If leisure is an inferior good then the net effect is clear. Higher wages will induce us to consume less of it and vice versa.
Compare and contrast the concepts of income and wealth. Are these measured as a stock or a flow? Explain.
Wealth, or net worth, is the total value of what an entity owns minus what it owes. It is a stock measure because wealth is measured at a given point in time. Income is the sum of all wages, salaries, profits, interest and other forms of earnings for an entity over a given period of time. Because it is measured over a period of time, it is a flow measure.
Assume that there is a shortage of lobster and that for whatever reason prices have not risen to choke off the excess demand. Instead, the government has exhorted people to voluntary refrain from lobster consumption to "maintain a balance between supply and demand." Assume that the temporary public service announcements are "effective" and the public reduces its consumption of lobster. Explain using supply and demand analysis what should happen to the equilibrium quantity of lobster and its equilibrium price. Why would this plan not have much of an impact on the lobster market in the long run?
The reduction in demand would keep prices from rising. But it would also result in a decrease in the equilibrium quantity(Qe) of lobster sold in the market as fishermen move down and along their supply curve and cut back production. This plan is not likely to have much effect in the long run since the campaign is temporary. As soon as the government stops making the public service announcements or as people simply go back to their same demand preferences it is likely in the long run that an increased demand for lobster will result in higher lobster prices and a higher equilibrium quantity of lobster.
There is a practice in the stock market known as "short selling" whereby an individual will borrow stock from someone, turn around and sell it and then buy it back when it's price has fallen in order to return the stock back to the lender. What expectation does this short seller have about the price of this company's stock? How can he/she expect to make money at this practice? What could go wrong that might cost him money?
The short seller is expecting that the price of the stock will fall. By borrowing the stock and then selling it immediately he/she is anticipating that the price of the stock will fall. If it falls after he/she sells it and before he/she needs to return the stock to the lender he/she makes money from the transaction by pocketing the difference. If however, he/she is wrong and the price of the company's stock rises after he/she sells it he suffer losses by the amount by which the stock's price has risen times the number of shares he/she borrowed.
A video rental store rents old movies for $1.50 per day. On average, 300 movies are rented each day. The store receives several copies of a new smash movie just released in video and decides to rent these movies at $3.50 per day. Now, 400 movies are rented each day. Thus, though the average rental price of a movie increased, the quantity rented increased Does this mean that the law of demand does not hold for this market?
The two types of movies (old and new release) represent two different markets. Thus, there is a demand for old movies and a demand for new releases. Both of these demand curves would be downward sloping, meaning that the law of demand applies.
Suppose a long lost relative died and left you a trust fund worth $1 million that you will receive ten years from now. What effect, if any, will this have on your demand for airline travel? (Assume that airline travel is a normal good.)
This will likely increase your demand for airline travel, shifting the curve to the right
Define the following: market equilibrium, surplus, and shortage.
When a market is in equilibrium, quantity supplied(Qs) is equal to quantity demanded(Qd). Qs =Qd at the equilibrium price If quantity supplied is greater than quantity demanded Qs > Qd , there is a surplus. If quantity demanded is greater than quantity supplied Qd> Qs , there is a shortage.
You are a major stockholder of a large corporation. You have news from a credible source that the company's earnings report is going to indicate record losses. If you and other major stockholders receive the same news what is your likely behavioral response and what impact will that have on the price of the company's stock?
You and the other major stockholders may likely opt to sell either large chunks of your stock or perhaps all of your holdings. Either way the effect of all of this stock suddenly hitting the market all at once should have the effect of lowering the company's stock price.