Kapittel 2 - The basics of supply and demand

Question 1

What is the “workhorse of microeconomics”? Why?

Answer 1

We say that the supply and demand analysis is the grand foundation of microeconomics.

The reason is because supply and demand analysis tells us the overall tendencies in the market.

Question 2

Define the supply curve

Answer 2

The supply curve is a measure of the quantity of how much of a certain good or service that producers are willing to sell/produce at any given price, HOLDING EVERYTHING ELSE CONSTANT.

The result is an upward sloping function. The higher the price a producer can get, the higher quantity they want to sell. Keep in mind that this is when other factors, such as cost of production, remains constant. Therefore, the supply curve basically gives the relationship of what happens when the price goes up.

We actually focus on “willingness” a lot. A higher price increase firms’ willingness to produce and sell more. Willingness increase because we (the firms) get more payment for the delivery.

Question 3

Name variables other than price that affects supply

Answer 3

Production costs, wages, costs of raw materials, knowledge.

When we draw some supply curve, these variables are considered constants. Change them, and we get a shift in the curve.

Question 4

What happens to the supply curve if the costs of raw materials decrease?

Answer 4

We would have a willingness to produce more

When the costs decrease, it means that we can produce a higher quantity to the same price. Therefore, the entire supply curve shifts to the right.

The opposite would also be the case. If costs increase, the supply curve would shift to the left.

Question 5

What is “change in supply”?

Answer 5

Change in supply refers to shifts of the entire supply curve

Question 6

What is “change in the quantity supplied”?

Answer 6

Change in the quantity supplied refers to moving along the supply curve, ex new price leading to new quantity to sell.

Question 7

Define the demand curve

Answer 7

The demand curve displays the relationship between quantity demanded by consumers, and price.

In general, a higher price (all else constant) leads to a decline in demand.

Question 8

What affects the demand curve, other than price?

Answer 8

Income.

Question 9

How can one shift the demand curve to the left?

Answer 9

Shifting the demand curve to the left means that if the price were to remain the same, the quantity demanded would be smaller than before. This corresponds to a decrease in income.

Question 10

How can one shift the demand curve to the right?

Answer 10

If the demand curve shifts to the right, and the price remains the same, the quantity demanded would increase. This corresponds to an income increase.

At the same time, given an income increase, we would expect firms to increase prices, which would decrease the quantity demanded.

By setting up the price you could get the same quantity demanded as before. Therefore, if the demand is sort of given (people need it, and tend to buy the same amount anyways) price would typically increase lots.

Question 11

Define substitue goods

Answer 11

We say that goods are substitutes if an increase in price of A leads to an increase in demand of B.

In other words, if one good become more expansive, you’d see substitutes being more popular.

The opposite is also true: Two goods A and B are substitutes if decrease in price of A leads to decrease in demand of B

Question 12

Another word for equilibrium price?

Answer 12

market clearing price

Question 13

What is the equilibrium price?

Answer 13

The equilibrium price refers to the price where the quantity supplied is equal to the quantity demanded.

Question 14

What do we mean by “market mechanism”?

How does it work?

Answer 14

When we talk about the market mechanism, we refer to the tendency of the price to be pushed towards the equilibrium price.

Consider a scenario where the price is above the equilibrium price. Then the quantity supplied would be greater than the quantity demanded. This means that we get a surplus of goods. Firms generally dont want this, and reduce the price in order to get rid of the surplus.
In other words: Producers are more willing to produce goods than buyers are in actually buying them. This gives the surplus.

Question 15

How do firms prevent a surplus from growing?

Answer 15

Firms typically decrease the price. This works because a lower price cause higher demand. Higher demand leads to less surplus.

Question 16

If we are a firm, and we notice a shortage on our goods, what do we do?

Answer 16

We up the price.

A shortage occurs when the quantity demanded is greater than the quantity supplied. We need to find the intersection between the demand curve and supply curve, which we do by upping the price.

Question 17

What is the assumption that make the supply and demand model work?

Answer 17

That the market is at least roughly competitive.

Question 18

What is elasticity?

Answer 18

Elasticity measure sensitivity of one variable in regards to another.

Specifically: Elasticity is a number that tells us the percentage change that will occur in one variable in response to a 1% change in another variable.

For instance: The price elasticity of demand, measure the change in demand when price change 1%.

The variable above the brøkstrek is the one that we measure sensitivity to.

Question 19

What is price elasticity of demand?

Answer 19

Ep = relative change in quantity demanded divided by relative change in price.

Question 20

What is “magnitude” of price elasticity?

Answer 20

The absolute value of the number we get. The number tends to be negative because a price increase typically lead to decrease in quantity demanded. Therefore, we use the magnitude to refer to the absolute value of this number.

Question 21

What do we mean by “demand is price elastic”?

Answer 21

If we say that demand is price elastic, it means that the magnitude is greater than 1. This means that a change in price leads to an even greater change in the quantity demanded.

Question 22

What generally determines whether a market for some good is elastic or inelastic?

Answer 22

The amount of substitutes. More substitutes allows elastic tendencies.

Question 23

What is the mathematical representation of price elasticity of demand?

Answer 23

Ep = change in quantity demanded divided by change in price, times the ratio of Price divided by Quantity demanded.

The first ratio can be calculated as the derivative.

Question 24

Does the linear demand curve have constant elasticity?

Answer 24

No. While the ratio of changes is constant, the ratio of price/quantity does not

Question 25

Define completely elastic and completely inelastic demand

Answer 25

COMPLETELY elastic: A single price level cause us to by everything we can.

Completely inelastic: A single quantity that we buy regardless of price.

Question 26

What is the income elasticity of demand?

Answer 26

The income elasticity of demand is the percent change in demand that results from a 1% change in income.

E_{I} = same as for price, but with income instead.

Question 27

What is cross-price elasticity of demand?

Answer 27

Cross price elasticity of demand attempts to capture how some goods are affected by others.

Cross price elasticity of demand is calculated by using the relative change in quantity demanded of A, and divide this by the relative price change of B.

Question 28

When using the cross price elasticity of demand, how can we tell whether goods are substitutes or complements?

Answer 28

Since substitutes defines the relationship “if price of A increase, the quantity demanded of B increase”, if the cross price elasticity is POSITIVE, we have substitutes. If negative, they are complements.

Question 29

What is price elasticity of supply?

Answer 29

Same as with demand, but this is usually positive, as increase in price typically leads to increase in quantity supplied.

Question 30

Define arc elasticity

Answer 30

Arc elasticity is the same as regular, but we consider a significant jump in prices. When we calculate this, we use the average price and the average quantity demanded along the arc of interest.’

The formula for arc elasticity is the same as with regular elasticity, but we change the P/Q factor to be P_avg/Q_avg.

E_arc = dQ/dP * P_avg/Q_avg

The reason why use average values is to better capture teh entire effect. This can be relevant in cases where we actually change the price from say 50 to 60 nok, and want the measure the elasticity based on this change. A single point estimate of the elasticity might not be accurate enough.

Question 31

Are there any differences between short term and long term supply and demand?

Answer 31

Short time (about a year) and long term (until consumers and producers adjust fully to the price change) are very different.

For instance, some goods might experience some drop off because of a sharp increase in price. However, the long term effect can be even more dramatic. The gasoline price and cars are a good an example. If gas becomes expensive, the greatest consequence comes from people starting to buy electric vehicles instead. However, this is long term.

Question 32

IMP:

Elaborate on the supply curve

Answer 32

The supply curve shows the relationship between what quantities producers are willing to sell at a given price, HOLDING EVERYTHING ELSE EQUAL.

In general, the higher the price, the more willing a firm will be to produce more.
The idea is the because everything else remains the same, if we suddenly could get more bucks for our units, then it directly translates to more profit. Therefore, we are willing to produce more.

Hidden behind the supply curve, we can find other variables that affect the shift of supply:
Production costs
Wages
interest charges
costs of raw materials

So, basically, the costs.

Question 33

There are four different types of elasticity we are concerned with. Name and define them

Answer 33

1) Price elasticity of demand: P/Q * dQ/dP

2) Income elasticity of demand: I/Q * dQ/dI

3) Cross-price elasticity of demand: P_other/Q_this * dQ_this/dP_other (change in demand for our “this” good as an effect of price change of the other good)

4) Price elasticity of supply:
P/S * dS/dP

Question 34

What exactly does elasticity tell us

Answer 34

Elasticity tells us the change in percent that results from a 1% change in something.

Question 35

Is there a difference between demand in short term and long term?

Answer 35

Yes. Demand tends to be more elastic in the long run. This is because it usually takes some time for both producers and consumers to react to changes.

An example of this is the price of gasoline. At first, since people dont have a choice, gasoline is relatively inelastic. However, when people fuck off and buy electric cars, the demand of gasoline will suddenly become very elastic from a long-run perspective.

You also have durables, which are goods that we need to change every now and then. For instance a freezer.