2.1 demand and supply analysis

Question 1

Economics

Answer 1

the study of production, distribution, and consumption

Question 2

Macroeconomics

Answer 2

deals with aggregate economic quantities

Question 3

Microeconomics

Answer 3

focuses on individual economic units

Demand and supply analysis is the key to microeconomics

Question 4

Elasticity

Answer 4

the ratio of percentage changes and does not depend on the underlying units

Question 5

inelastic demand

Answer 5

If demand is not very sensitive to price

This corresponds to an own-price elasticity between -1 and +1

Question 6

unit elastic

Answer 6

elasticity is -1

Question 7

the demand is elastic for lower quantities or higher quantities according to the linear demand curve

Answer 7

lower quantities

Question 8

the demand is inelastic for lower quantities or higher quantities according to the linear demand curve

Answer 8

higher quantities

Question 9

ith a vertical demand curve, the quantity demanded is the same regardless of the price. This is not possible at all prices, but it is often true over a specified price range

how elastic is this?

Answer 9

This means the demand is perfectly inelastic, which means it has zero elasticity.

Question 10

A horizontal demand curve implies the consumers will buy an infinite amount at a given price, but zero at a price just a little bit greater. This is often true for perfectly competitive markets like the wheat market

how elastic is this?

Answer 10

The demand is perfectly elastic and thus has infinite elasticity

Question 11

how does the existence of close substitutes impact own-price elasticity?

Answer 11

the own-price elasticity of demand is likely high

Consumers could just switch to a competitors’ product

If there are no close substitutes, then the demand will be much less elastic

Question 12

If the product is a small portion of people’s budgets, then the demand elasticity is high or low?

Answer 12

low

people would not likely buy less toothpaste even if the price of toothpaste rises by 10%

Question 13

The long-run demand is typically more elastic than the short-run demand

why?

Answer 13

Consumers have more time to adjust behaviors to changing prices. But this is not true for durable goods like washing machines. People would likely react to a drop in prices in the short-term but would not purchase more washing machines in the long run

Question 14

When demand is elastic, the price and total expenditure move in opposite directions

what does this mean?

what about when demand is inelastic?

Answer 14

if the price decreases, the total expenditure will increase

This occurs because the percentage change in quantity is bigger than the percentage change in price

When demand is inelastic, the price and total expenditure move in the same direction

Question 15

when will the total expenditure for a good or service be maximized?

Answer 15

at the quantity that is associated with the unit elastic point on the demand curve

Question 16

Income elasticity of demand

Answer 16

the percentage change in the quantity demanded divided by the percentage change in income

Income elasticity can be negative, positive, or zero

Question 17

normal goods

Answer 17

consumption goods have positive income elasticity

the quantity demanded will increase when income increases

Question 18

inferior goods

Answer 18

goods with negative income elasticity

Question 19

The cross-price elasticity will be positive or negative for close substitutes?

Answer 19

Positive

As the price rises on good Y, people will be inclined to purchase more of good X

Question 20

The cross-price elasticity is positive or negative for goods that are complements?

Answer 20

Negative

These goods are normally consumed together

Question 21

the substitution and income effect

Answer 21

When the price of a good like beef falls, people will tend to buy more beef than chicken. It is relatively cheaper than chicken, so the consumer will substitute beef for chicken

When the price of a good falls, it also leaves the consumer with more purchasing power or real income. Consumers will tend to buy more goods with this extra income. That is the income effect

Question 22

Giffen goods

Answer 22

The income effect could overpower the substitution effect for some inferior goods. This means more of a good would be consumed as prices rise

The slope of the demand curve would be positive

Question 23

Veblen goods

Answer 23

For some goods, a high price tag may drive consumer demand. This could be true for fancy jewelry or cars

positively sloped demand curves

Question 24

For a negatively sloped linear demand curve, own-price elasticity is most likely:

A
highest at relatively high prices.

B
the same at all points along the curve.

C
highest at relatively high levels of quantity demanded.

Answer 24

A
highest at relatively high prices.

Question 25

The shape of the demand curve for a good that is sold in a perfectly competitive market is most likely:

A
vertical.

B
horizontal.

C
upward-sloping.

Answer 25

B
horizontal.

In a perfectly competitive market, demand is perfectly elastic. In such conditions, the demand curve is horizontal because the same price is paid for any quantity sold. A seller cannot obtain a higher price than the market price because goods are perfect substitutes.

Question 26

increasing marginal returns

Answer 26

each additional resource will produce an increasing amount of output

Firms can experience this as they add more labor to the production process that optimizes efficiency, taking advantage of specialization

Question 27

the law of diminishing marginal returns

Answer 27

Each additional unit of input will produce a smaller amount of output

Question 28

Accounting profit

Answer 28

net income. It equals revenue less accounting costs (or explicit costs)

Question 29

Economic profit is also known as abnormal or supernormal profiit

Answer 29

the total revenue less economic costs (sum of accounting costs and implicit opportunity costs).

This measure of profit focuses on forward-looking depreciation, which is based on the opportunity cost of the fixed capital

Question 30

Firms in a perfectly competitive environment are price takers

Answer 30

They operate with a perfectly elastic, horizontal demand curve

The total revenue equals the price times the quantity

The total revenue is linear, with the slope equal to the price per unit.

Question 31

in a imperfect competition, profit is maximized when:

Answer 31

1. The marginal revenue (MR) equals the short-term marginal cost (SMC)
2. SMC is rising

Question 32

in a perfect competition, profit is maximized when:

Answer 32

so profit is maximized when the price equals SMC.

Question 33

Firms operating in a perfectly competitive environment may only expect to earn which type of profit

Answer 33

a normal profit

That means the economic profit is zero because the capital is just earning a rate commensurate with the risk

Profit above this point would attract competitors, which would drive the profitability down

Zero economic profit is still a positive accounting profit

Question 34

he short-run average total cost (SATC) curve

Answer 34

defines the per-unit cost in the short run

It is dependent on the choice of technology, physical capital, and plant size

Question 35

The long-run average total cost (LRAC) curve

Answer 35

derived from the SATCs available to the firm. For example, each SATC could utilize a different type of technology

Question 36

how can a firm gain economies of scale

Answer 36

by growing provided the output increases faster than the inputs

Question 37

when do diseconomies of scale occur

Answer 37

if the increase in output is slower than the increase in input

Question 38

the minimum efficient scale (MES)

Answer 38

The minimum per unit cost is the dividing line between economies of scale and diseconomies of scale

Question 39

Economies of scale can come from factors such as

Answer 39

Increasing returns to scale (increases in output are proportionately larger than increases in inputs)

Specialization in functions

Purchasing more expensive but more efficient equipment

Reducing waste

Better use of market information

Obtaining discounted prices on inputs from bulk purchases

Question 40

Diseconomies of scale can come from factors such as:

Answer 40

Decreasing returns to scale

(increases in output are proportionately smaller than increases in inputs)

Cumbersome management

Duplication of business functions

Higher resource prices due to supply constraints

Question 41

in the short run, maximum profit (or minimal loss) is determined when

Answer 41

marginal cost equals marginal revenue

Question 42

To maximize long-run profit under perfect competition, a firm should operate at which level

Answer 42

the minimum efficient scale point

Economic profit is zero in the long run under perfect competition

Question 43

A company that expects total revenue to be less than its total cost but greater than its total variable cost over the long term, will most likely:

A
exit the market.

B
continue operating.

C
temporarily suspend operations.

Answer 43

A
exit the market

When total revenue is sufficient to cover total variables costs but not the total cost, a firm can continue to operate in the short-run. However, if these conditions are expected to continue over the long term, the company should exit the market