2- Supply and Demand

Question 1

What is a Market in economics?

Answer 1

• A market is a setting where buyers and sellers interact to exchange goods or services.
• It enables the efficient allocation of resources, allowing consumers to purchase what they need and producers to sell their goods and services

Question 2

What does the Demand Curve represent?

Answer 2

• Income Effect: As prices increase, the purchasing power of consumers diminishes, reducing the quantity they can afford.
• Substitution Effect: Higher prices incentivize consumers to substitute the good with relatively cheaper alternatives.
• Cost-Benefit Principle: Elevated prices reduce the perceived net benefit of consumption, thereby decreasing demand

Question 3

What are exceptions to the law of demand?

Answer 3

• Veblen Goods: For certain luxury goods, demand may increase as price rises, due to their status symbol value.
• Quality Signaling: Higher prices can serve as an indicator of superior quality, leading to increased demand.
• Future Price Expectations: Anticipation of future price increases can prompt higher current demand, as consumers seek to avoid higher costs later

Question 4

What is the Supply Curve and why does it typically slope upwards?

Answer 4

• The supply curve illustrates the relationship between the price of a good and the quantity producers are willing to supply.
• It generally slopes upward because higher prices provide producers with the incentive to increase output, especially when additional production involves higher marginal costs

Question 5

What are the determinants of demand?

Answer 5

• Price of Related Goods: The prices of substitutes or complements significantly influence demand.
• Income: Changes in consumer income can either increase demand for normal goods or decrease demand for inferior goods.
• Preferences: Shifts in consumer tastes or preferences, often influenced by cultural or social factors, can alter the demand curve

Question 6

What causes shifts in the supply curve?

Answer 6

• Technological Advances: Improvements in production technology enhance efficiency, shifting the supply curve to the right.
• Input Costs: Increases in the costs of production inputs shift the supply curve to the left, while decreases shift it to the right.
• Number of Suppliers: An increase in the number of firms in the market results in a rightward shift in the supply curve, indicating greater overall supply

Question 7

What is Market Equilibrium?

Answer 7

• Market equilibrium is achieved when the quantity demanded by consumers equals the quantity supplied by producers, resulting in a stable price at which no surplus or shortage exists.
• At equilibrium, the market efficiently allocates resources, and there are no inherent pressures for price adjustment

Question 8

What are price controls, and how do they impact markets?

Answer 8

• Price Ceilings: Government-imposed maximum prices can lead to shortages, as the quantity demanded exceeds the quantity supplied.
• Price Floors: Minimum price restrictions can lead to surpluses, where the quantity supplied exceeds the quantity demanded.

Both types of price controls distort the natural market equilibrium, leading to inefficiencies and welfare losses

Question 9

What is Pareto Efficiency in the context of market equilibrium?

Answer 9

• A market is Pareto efficient if no individual can be made better off without making another individual worse off, indicating an optimal allocation of resources.
• Market equilibrium typically achieves Pareto efficiency, although it does not necessarily ensure equity or fairness in distribution

Question 10

What are the rationing and allocative functions of prices?

Answer 10

• Rationing Function: Prices ration scarce resources by allocating goods to those willing and able to pay the highest price.
• Allocative Function: Prices direct resources towards their most valued uses, ensuring that production aligns with consumer preferences

Question 11

How do price supports affect markets?

Answer 11

• Price Supports: Government interventions to maintain prices above equilibrium, often used in agriculture to support farmers’ incomes.
• These supports lead to surpluses, as producers are incentivised to produce more than what is demanded at the supported price

Question 12

What is excess supply?

Answer 12

• Occurs when the quantity supplied exceeds the quantity demanded at a given price, leading to downward pressure on price until equilibrium is restored.

Question 13

What is excess demand?

Answer 13

• Occurs when the quantity demanded exceeds the quantity supplied at a given price, leading to upward pressure on price until equilibrium is reached