Chapter 2



Chapter 2MARKET TRANSACTIONS: DEMAND AND SUPPLY ANALYSIS5080412750The Chapter in a Nutshell00The Chapter in a NutshellA market is a mechanism through which buyers and sellers communicate to trade goods and services. Through the price system, markets link potential buyers to potential sellers.Demand is a schedule that shows various amounts of a good or service buyers are willing and able to purchase at each possible price during a particular period. A demand curve is a graphical portrayal of the data comprised by a demand schedule. A movement along a demand curve, resulting from a change in price, is called a change in quantity demanded.According to the law of demand, price and quantity demanded are inversely related, assuming the other factors affecting the quantity demanded remain the same. Economists explain the law of demand in terms of the substitution effect, the income effect, and the principle of diminishing marginal utility.A demand shifter is a variable that causes a shift in a demand curve. Among the most important demand shifters are consumer tastes, number of buyers, consumer income, prices of related goods, and expected future prices. When a demand shifter causes an increase in demand, the demand curve shifts rightward; a decrease in demand is shown by a leftward shift in the demand curve.Supply is a schedule or curve showing the amounts of a good or service that firms or households are willing and able to sell at various prices during a specified period. The quantity supplied refers to a single point on a supply curve. Changes in quantity supplied are caused by changes in the price of the product.According to the law of supply, sellers are willing and able to make available more of their product at a higher price than a lower price, other determinants of supply being constant. The tendency for the cost of additional output to increase explains the law of supply.A supply shifter is a variable that causes a shift in a supply curve. Among the major supply shifters are resource prices, technology, prices of other goods, expected future prices, taxes and subsidies, and the number of suppliers. When a supply shifter results in an increase in supply, the supply curve shifts rightward; a decrease in supply is shown as a leftward shift in the supply curve.In a competitive market, equilibrium occurs when the price of a product adjusts so that the quantity that consumers will purchase at that price is identical to the quantity that suppliers will sell. The price that sets buyers’ intentions equal to sellers’ intentions is called the equilibrium price. A surplus of a product results in price falling to its equilibrium level; a shortage of a product results in price rising to its equilibrium level.Concerning shifts in the demand curve or supply curve, we can make the following predictions, other factors remaining constant:When demand increases, both the equilibrium price and the equilibrium quantity increase.When demand decreases, both the equilibrium price and the equilibrium quantity decrease.When supply increases, equilibrium price falls and equilibrium quantity rises.When supply decreases, equilibrium price rises and equilibrium quantity falls. Chapter ObjectivesAfter reading this chapter, you should be able to:Identify the major factors affecting demand.Identify the major factors affecting supply.Explain how prices and quantities are determined in competitive markets.Explain why prices sometimes decrease, and sometimes increase.Predict how prices and quantities will respond to changes in demand or supply.042545Knowledge Check00Knowledge CheckKey Concept Quizsubstitution effectincome effectdiminishing marginal utilitychange in demandchange in quantity suppliednormal goodcomplementary goodmarket equilibriumsurplusshortage law of demandlaw of supply_____ a.price and quantity demanded are negatively related _____ b.when quantity supplied exceeds quantity demanded_____ c.consumers substitute the cheaper good_____ d.price and quantity supplied are positively related_____ e.consumers experience a decline in the purchasing power of their income when price increases_____ f.is caused by a change in price_____ g.when quantity supplied equals quantity demanded_____ h.each additional unit provides less and less utility_____ i.goods that go together_____ j.when quantity demanded exceeds quantity supplied_____ k.something you buy more of when income increases_____ l.a change in the demand scheduleMultiple Choice QuestionsThe law of demand states that a. price and quantity demanded have a positive relationship b. price and quantity demanded have no relationship c. price and quantity demanded have a negative relationshipd. when price increases, quantity demanded also increasesIf the price of computers decreases,the demand for compatible software increases the demand for compatible software decreases c. the demand for computers increases d. there is no effect in the market for computers3. If used cars are inferior goods and incomes declinesales of new cars remain unchanged b. sales of used cars decline c. sales of new cars increased. sales of used cars increaseIf Burger King lowers the price of its hamburgersdemand for McDonald hamburgers increases b. demand for Burger King hamburgers increases c. demand for McDonald hamburgers decreasesd. demand for Burger King hamburgers decreasesIn voting for subsidies to dairy farmers, a legislator ishelping to decrease the supply of dairy products b. helping to increase the supply of dairy products c. wasting taxpayer dollarsd. helping allocate resources efficientlyIf the supply of good X increases and the demand for good X remains the same the equilibrium price rises b. the equilibrium quantity decreases c. the equilibrium price remains unchangedd. the supply curve shifts to the rightWhen the demand for computers increases and the salaries in the computer industry also increasethe equilibrium price and quantity of computers decrease b. the equilibrium price of computers increases c. the equilibrium quantity of computers increases d. the equilibrium quantity of computers decreasesSuppose that the equilibrium price of CD players increases due to an increase in consumer incomes. If the supply of CD players remains stablea. equilibrium quantity must increaseb. equilibrium quantity will remain unchangedc.CD players are inferior goodsthere is a decrease in the quantity demanded of CD playersDue to improvement in productivity, Boeing is able to reduce its production time. At the same time demand for Boeing airplanes falls due to an economic downturn in Asia. This will lead toa decrease in the equilibrium quantity of Boeing airplanes an increase in the equilibrium quantity of Boeing airplanesa decrease in the equilibrium price of Boeing airplanesan increase in the equilibrium price of Boeing airplanesIf California orange growers experience labor shortages due to stricter restrictions on immigrant pickers, while the demand for oranges remains stablea.the equilibrium price of oranges will increaseb.the equilibrium quantity of oranges will increase the supply of oranges will remain unchangedthe equilibrium price of oranges will remain unchanged11.When new Internet companies enter existing markets, they help toa.increase the demandb.increase the supplydecrease the equilibrium quantitiesincrease the equilibrium prices12.The supply curve illustrates howquantity supplied increases as price decreasesquantity supplied increases as price increasesquantity supplied increases as technology improvesquantity supplied increases as resource prices decrease13.The demand curve for Coca Cola would most likely shift to the left in response to a (an)decrease in the price of corn nuts which are consumed with Coca Colaincrease in the money income of householdsdecrease in the price of Coca Coladecrease in the price of Pepsi Cola14.In a free market, the pricing system would ration natural gas to those buyers whoowned the most homes that were heated with furnaces using natural gashad the greatest amount of incomedid the best job of conserving natural gaswere willing and able to pay the highest price15.When Mary purchases dresses, her gains in satisfaction become smaller as successive dresses are purchased. Therefore, Mary will purchase additional dresses only if their price declines. Which of the following applies to this situationincome effectsubstitution effectlaw of diminishing marginal utilitylaw of decreasing opportunity costs16. A producer’s supply curve is upward sloping whena.production costs of additional units of output increaseb. the producer envisions an inverse relationship between price and quantity suppliedc. the producer realizes decreased profits as output expandsd. mass production efficiencies take place as output expands17.The income effect, substitution effect, and law of diminishing marginal utility explaina.why the demand curve for a product is downslopingb.why the demand curve for a product is upslopingc.why the supply curve of a product is downslopingd.why the supply curve of a product is upsloping18. A movement along the demand curve for HP computers will occur in response toa.a change in buyer incomeb.a change in the price of HP computersc.a change in the price of Gateway computersd.buyer expectations of changing future prices of HP computers 19. The production of additional barrels of oil tends to entaila.increasing costsb.constant costsc.decreasing costsd.zero costs20. If the demand for coal increases more than the supply of coal, we would expecta.a decrease in market quantity and a decrease in priceb.a decrease in market quantity and an increase in pricec.an increase in market quantity and a decrease in pricean increase in market quantity and an increase in price21. Rush-hour congestion on the highways of large cities could be reduced by all of the following excepta.building additional highwaysb.encouraging people to travel on buses or subwaysc.assessing drivers tolls during peak driving periods of the dayd.decreasing the cost of a driver’s license True-False Questions1.TFChange in quantity demanded and change in demand are identical concepts.2.TFThe principle of diminishing marginal utility implies that total satisfaction declines when more of a good is consumed. 3.TFWhen a good is inferior and income decreases, we buy more of the good.4.TFFuture prices have no effect on quantity demanded.5.TFWhen the price changes, the demand changes as well.6.TFIf the price of a substitute in production changes, the supply curve shifts.7.TFA decline in resource prices and a tax cut have similar effects on supply.8.TFA shortage causes prices to decline.9.TFIf demand decreases while supply remains stable, a temporary surplus ensues.10.TFWhen both supply and demand change simultaneously, it is not possible to determine the direction of change for both equilibrium price and quantity.11.TFWhen there is excess supply in the market, prices will tend to move down.12.TFIf people take more vacations when incomes increase, vacations are normal goods.13.TFOther things remaining constant, if the demand for Coca-Cola decreases due to a health scare in Europe, the equilibrium price of Coca-Cola also decreases.14. T F If the productivity of the U.S. worker improves in the software industry, the equilibrium price of software will increase. 15.TFPrices react to shortages and surplus and move the market back to equilibrium.16.TFA tax on cigarettes reduces the demand for cigarettes.17.TFA subsidy placed on the production of steel lowers the price of steel.18.TFAn increase in the demand for software engineers increases the supply of software engineers.19.TFOther things remaining the same, a decrease in the annual fees charged by credit card companies would increase the demand for credit cards.20.TFA decrease in the price of steel would increase the supply of automobiles.21.TFCompared to motorists in many European countries, American motorists tend to pay higher taxes for each gallon of gas.22.TFEconomic theory predicts that at least part of the current nursing shortage would be eliminated if wages were increased for nurses.23.TFIf the demand curve for wheat decreases more than the supply curve of wheat, the price of wheat will rise while equilibrium quantity will decrease.24.TFThe production of oil tends to be consistent with the law of supply.25.TFAn increase in the price of beans will cause the supply curve of beans to shift rightward.26.TFThe income effect and substitution effect explain why the supply curve of wheat is upsloping.27.TFA market is a mechanism through which buyers and sellers communicate to trade goods and services.28.TFAn increase in demand suggests that a buyer is willing and able to purchase a larger quantity at a particular price.Application Questions_________________________________ QuantityQuantityPrice Demanded Supplied____________________________________ $100 1000 200$200 800 400 $300600600$400 400800$500 200 1000_________________________________1. The table above describes the market for VCRs. Plot the demand and supply schedules. What is the equilibrium price? The equilibrium quantity?At the price of $200, what is the quantity demanded? What is the quantity supplied? Will price tend to increase?At the price of $400, what is the quantity demanded? What is the quantity supplied? Will price tend to decrease?A new product, DVD is introduced into this market and consumers prefer it to VCRs. The new demand schedule for VCRs is represented in the following table._______________________________ Quantity Demanded Price of VCRs _______________________________ $100 800 $200 600 $300 400 $400 200 $500 0_______________________________Plot the new demand schedule. What is the direction of the shift in the demand curve?What is the new equilibrium price and quantity?Is there an excess demand or excess supply at the old equilibrium price?3.Now the VCR producers organize and are able to secure a subsidy for production. What will happen to the supply schedule? Will this new equilibrium quantity and price be more or less than the answer to question 2a? -1143000Answers to Knowledge Check Questions00Answers to Knowledge Check QuestionsKey Concept Answers1.c7.i2.e8.g3.h9.b4.l10.j5.f11.a6.k12.dMultiple Choice Answers1.c5.b9.c13.d17. a21. d2.d6.d10.a14.d18. b3.c7.b11.b15. c19. a4.c8.a12.b16. a20. dTrue-False Answers1.F6.T11.T16.F21.F26.T2.F7.T12.T17.T22.T27.T3.T8.F13.T18.F23.F28.T4.T9.T14.F19.F24.T5.F10.T15. T20.T25.FApplication Question Answers 1. a. Equilibrium price = $300 Equilibrium quantity = 600 VCRsQuantity demand = 800 VCRsQuantity supplied = 400 VCRsYes, there is a shortage and price will increase.Quantity demanded = 400 VCRsQuantity supplied = 800 VCRsYes, there is a surplus and price will decline. a. The demand curve shifts to the leftEquilibrium price = $250Equilibrium quantity = 500 VCRsThere is an excess supply at the old equilibrium price.The supply curve will shift to the right. The equilibrium price will be lower and the quantity will be higher. ................
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