Chapter 3

Question 1

Big Question: What are the fundamentals of markets?

Answer 1

1. A market consists of a group of buyers and sellers for a particular product or service.
2. A competitive market exists when there are so many buyers and sellers that each has only a small impact on the market price and output.
3. Not all markets are competitive. When firms have market power, markets are imperfect.

Question 2

Big Question: What determines demand?

Answer 2

1. The law of demand states that all other things being equal, quantity demanded falls when the prices rise, and rises when the prices falls.
2. The demand curve is downward sloping.
3. A price change causes a movement along the demand curve, not a shift of the curve.
4. Changes in something other than the price (including changes in incomes, the price of related goods, changes in tastes and preferences, price expectations, the number of buyers, and taxes) shift the demand curve.

Question 3

Big Question: What determines supply?

Answer 3

1. The law of supply states that all other things being equal the quantity supplied of a good rise when the price of the good rises, and falls when the good falls.
2. The supply curve is upward-sloping.
3. A price change causes a movement along the supply curve, not a shift of the curve.
4. Changes in something other than price (the cost of inputs, changes in technology or the production process, taxes and subsidies, the number of firms in the industry, and price expectations) shift the original supply curve.

Question 4

Big Question: How do supply and demand interact to create equilibrium?

Answer 4

1. Supply and demand work together in a market-clearing process that leads to equilibrium, the balancing point between the two forces. The market-clearing price and output are determined at the equilibrium point.
2. When the price is about the equilibrium point, a surplus exists and inventories build up. Suppliers lower their price in an effort to sell the unwanted goods. The process continues until the equilibrium is reached.
3. When the price is below the equilibrium point, a shortage exists and inventories are depleted. Suppliers raise the price until the equilibrium point is reached.

Question 5

What is a market economy?

Answer 5

Where resources are allocated among households and firms with little or no government interference.