Ch 3

Question 1

Every society answers three basic questions

Answer 1

WHAT
Which goods will be produced? 
How much of each?
HOW
Which technology?
Which resources are used?
FOR WHOM
How are outputs distributed?
Need?
Income?

Question 2

Central Planning

Answer 2

Decisions by individuals or small groups

Question 3

The market for any good consists of all the buyers and sellers of the good

Answer 3

Buyers and sellers have different motivations

• Buyers want to benefit from the good
• Sellers want to make a profit

Question 4

Demand curve

Answer 4

illustrates the quantity buyers would purchase at each possible price

Demand curves have a negative slope

• Consumers buy less at higher prices
• Consumers buy more at lower prices

Question 5

Buyers value goods differently

Answer 5

• The buyer’s reservation price is the highest price an individual is willing to pay for a good
• Buy the good if the benefit exceeds the cost, i.e. the market price
• When the price increases it satisfies the cost-benefit principle for fewer buyers

Question 6

Demand reflects the entire market, not one consumer

Answer 6

• Lower prices bring more buyers into the market

- Lower prices cause existing buyers to buy more

Question 7

Origins of demand

Answer 7

• Wants (preferences, tastes): biological and cultural
• Peer influence
• Needs versus wants: bare subsistence in terms of food, shelter vs. wants

Question 8

What happens when price goes up?

Answer 8

The substitution effect: Buyers switch to substitutes when price goes up
The income effect: Buyers’ overall purchasing power goes down

Question 9

Horizontal interpretation of demand:

Answer 9

Given price, how much will buyers buy?

At a price of $4, the quantity demanded is 8,000 slices/day.

Question 10

Horizontal summation

Answer 10

adding quantities at fixed prices

Question 11

supply curve

Answer 11

illustrates the quantity of a good that sellers are willing to offer at each price
- If the price is more than opportunity cost, offer more

Question 12

Low-Hanging Fruit Principle

Answer 12

explains the upward sloping supply curve

Question 13

seller’s reservation price

Answer 13

is the lowest price the seller would be willing to sell for

- Equal to marginal cost

Question 14

A system is in equilibrium

Answer 14

when there is no tendency for it to change

Question 15

The equilibrium price

Answer 15

is the price at which the supply and demand curves intersect

Question 16

The equilibrium quantity

Answer 16

is the quantity at which the supply and demand curves intersect

Question 17

The market equilibrium

Answer 17

occurs when all buyers and sellers are satisfied with their respective quantities at the market price

Question 18

A price ceiling

Answer 18

is a maximum allowable price, set by law

Question 19

Rent controls

Answer 19

set a maximum price that can be charged for a given good

Question 20

A change in quantity demanded

Answer 20

results from a change in the price of a good.

Question 21

If buyers are willing to buy more at each price

Answer 21

then demand has increased

Question 22

A change in quantity supplied

Answer 22

results from a change in the price of a good.

Question 23

Supply increases

Answer 23

when sellers are willing to offer more for sale at each possible price

Question 24

Supply decreases

Answer 24

when sellers are willing to offer less for sale at each possible price

Question 25

Demand for a normal good

Answer 25

increases when income increases

Question 26

Demand for an inferior good

Answer 26

increases when income decreases

Question 27

A change in the price of an input

Answer 27

Fiberglass for skateboards, construction wages

Question 28

Causes of Shifts in Supply

Answer 28

A change in the price of an input A change in technology Weather (agricultural commodities and outdoor entertainment) Number of sellers in the market Expectation of future price changes (Price changes never cause a shift in supply)

Question 29

Supply and Demand Shifts: Four Rules

Answer 29

1. An increase in demand will lead to an increase in both equilibrium price and quantity 2. An decrease in demand will lead to a decrease in both equilibrium price and quantity 3. An increase in supply will lead to a decrease in the equilibrium price and an increase in the equilibrium quantity. 4. An decrease in supply will lead to an increase in the equilibrium price and a decrease in the equilibrium quantity.

Question 30

Efficiency and Equilibrium

Answer 30

- Markets communicate information effectively - Markets maximize the difference between benefits and costs (economic surplus) - Market outcomes are the best provided that

Question 31

Buyer's surplus

Answer 31

buyer's reservation price minus the market price

Question 32

Seller's surplus

Answer 32

market price minus the seller's reservation price

Question 33

Total surplus

Answer 33

buyer's surplus + seller's surplus | - Total surplus is buyer's reservation price – seller's reservation price

Question 34

No cash on the table

Answer 34

when surplus is maximised | - No opportunity to gain from additional sales or purchases

Question 35

The socially optimal quantity

Answer 35

maximizes total surplus for the economy from producing and selling a good

Question 36

Economic efficiency

Answer 36

all goods are produced at their socially optimal level

Question 37

Efficiency Principle

Answer 37

equilibrium price and quantity are efficient if: - Sellers pay all the costs of production - Buyers receive all the benefits of their pur

Question 38

Efficiency

Answer 38

marginal cost equals marginal benefit

Question 39

Equilibrium Principle

Answer 39

a market in equilibrium leaves no unexploited opportunities for individuals

Question 40

Why do the prices of some goods go up during the months of heaviest consumption, while others go down?

Answer 40

- prices go up because demand increases. | - prices go down because supply increases.