Handout 2 - Ch 4

Question 1

What is a competitive market? Briefly describe a type of market that is not perfectly competitive.

Answer 1

A competitive market is a market in which there are many buyers and many sellers of an identical product so market is a monopoly, in which there is only one seller. There are also other markets that fall that each has a negligible impact on the market price. Another type of between perfect competition and monopoly.

Question 2

What are the demand schedule and the demand curve, and how are they related? Why does the demand curve slope downward?

Answer 2

The demand schedule is a table that shows the relationship between the price of a good and the quantity demanded. The demand curve is the downward-sloping line relating price and quantity demanded. The demand schedule and demand curve are related because the demand curve is simply a graph showing the points in the demand schedule. The demand curve slopes downward because of the law of demand—other things being equal, when the price of a good rises, the quantity demanded of the good falls. People buy less of a good when its price rises, both because they cannot afford to buy as much and because they switch to purchasing other goods.

Question 3

Does a change in consumers’ tastes lead to a movement along the demand curve or a shift in the demand curve? Does a change in price lead to a movement along the demand curve or a shift in the demand curve?

Answer 3

A change in consumers’ tastes leads to a shift of the demand curve. A change in price leads to a movement along the demand curve.

Question 4

Popeye’s income declines, and as a result, he buys more spinach. Is spinach an inferior or a normal good? What happens to Popeye’s demand curve for spinach?

Answer 4

Because Popeye buys more spinach when his income falls, spinach is an inferior good for him. His demand curve for spinach shifts out as a result of the decrease in his income.

Question 5

What are the supply schedule and the supply curve, and how are they related? Why does the supply curve slope upward?

Answer 5

A supply schedule is a table showing the relationship between the price of a good and the quantity a producer is willing and able to supply. The supply curve is the upward-sloping line relating price and quantity supplied. The supply schedule and the supply curve are related because the supply curve is simply a graph showing the points in the supply schedule. The supply curve slopes upward because when the price is high, suppliers’ profits increase, so they supply more output to the market. The result is the law of supply—other things being equal, when the price of a good rises, the quantity supplied of the good also rises.

Question 6

Does a change in producers’ technology lead to a movement along the supply curve or a shift in the supply curve? Does a change in price lead to a movement along the supply curve or a shift in the supply curve?

Answer 6

A change in producers’ technology leads to a shift in the supply curve. A change in price leads to a movement along the supply curve.

Question 7

Define the equilibrium of a market. Describe the forces that move a market towards its equilibrium.

Answer 7

At the equilibrium of a market is the point at which the quantity demanded is equal to quantity supplied. If the price is above the equilibrium price, sellers want to sell more than buyers want to buy, so there is a surplus. Sellers try to increase their sales by cutting prices. That continues until they reach the equilibrium price. If the price is below the equilibrium price, buyers want to buy more than sellers want to sell, so there is a shortage. Sellers can raise their price without losing customers. That continues until they reach the equilibrium price.

Question 8

Beer and pizza are complements because they are often enjoyed together. When the price of beer rises, what happens to the supply, demand, quantity supplied, quantity demanded, and the price in the market for pizza?

Answer 8

When the price of beer rises, the demand for pizza declines, because beer and pizza are complements and people want to buy less beer. When we say the demand for pizza declines, we mean that the demand curve for pizza shifts to the left as in Figure 5. The supply curve for pizza is not affected. With a shift to the left in the demand curve, the equilibrium price and quantity both decline, as the figure shows. Thus, the quantity of pizza supplied and demanded both fall. In sum, supply is unchanged, demand is decreased, quantity supplied declines, quantity demanded declines, and the price falls.

Question 9

Describe the role of prices in market economics.

Answer 9

Prices play a vital role in market economies because they bring markets into equilibrium. If the price is different from its equilibrium level, quantity supplied and quantity demanded are not equal. The resulting surplus or shortage leads suppliers to adjust the price until equilibrium is restored. Prices thus serve as signals that guide economic decisions and allocate scarce resources.

Question 10

Explain using supply and demand diagrams.

Answer 10

Cold weather damages the orange crop, reducing the supply of oranges and raising the price of oranges. This leads to a decline in the supply of orange juice because oranges are an important input in the production of orange juice. This can be seen as a shift to the left in the supply curve for orange juice. The new equilibrium price is higher than the old equilibrium price.

Question 11

Explain using supply and demand diagrams.

Answer 11

People often travel to the Caribbean from New England to escape cold weather, so the demand for Caribbean hotel rooms is high in the winter. In the summer, fewer people travel to the Caribbean, because northern climates are more pleasant. The result is a shift to the left in the demand curve. The equilibrium price of Caribbean hotel rooms is thus lower in the summer than in the winter, as the figure shows.

Question 12

Explain using supply and demand diagrams.

Answer 12

When a war breaks out in the Middle East, many markets are affected. Because a large proportion of oil production takes place there, the war disrupts oil supplies, shifting the supply curve for gasoline to the left, as shown in Figure 8. The result is a rise in the equilibrium price of gasoline. With a higher price for gasoline, the cost of operating a gas-guzzling automobile like a Cadillac will increase. As a result, the demand for used Cadillacs will decline, as people in the market for cars will not find Cadillacs as attractive. In addition, some people who already own Cadillacs will try to sell them. The result is that the demand curve for used Cadillacs shifts to the left, while the supply curve shifts to the right. The result is a decline in the equilibrium price of used Cadillacs.

Question 13

“An increase in the demand for notebooks raises the quantity of notebooks demanded but not the quantity supplied.” Is this statement true or false? Explain.

Answer 13

The statement, in general, is false. As Figure 10 shows, the increase in demand for notebooks results in an increased quantity supplied. The only way the statement would be true is if the supply curve was a vertical line, as shown in Figure 11.

Question 14

Consider the market for minivans. For each of the events listed here, identify which of the determinants of demand or supply are affected. Also indicate whether demand or supply increases or decreases. Then draw a diagram to show the effect on the price and quantity of minivans. - People decide to have more children.

Answer 14

If people decide to have more children, they will want larger vehicles for hauling their kids around, so the demand for minivans will increase. Supply will not be affected. The result is a rise in both the price and the quantity sold, as Figure 12 shows.

Question 15

Consider the market for minivans. For each of the events listed here, identify which of the determinants of demand or supply are affected. Also indicate whether demand or supply increases or decreases. Then draw a diagram to show the effect on the price and quantity of minivans. - A strike by steelworkers raises steel prices.

Answer 15

If a strike by steelworkers raises steel prices, the cost of producing a minivan rises and the supply of minivans decreases. Demand will not be affected. The result is a rise in the price of minivans and a decline in the quantity sold, as Figure 13 shows.

Question 16

Consider the market for minivans. For each of the events listed here, identify which of the determinants of demand or supply are affected. Also indicate whether demand or supply increases or decreases. Then draw a diagram to show the effect on the price and quantity of minivans. - Engineers develop new automated machinery for the production of minivans.

Answer 16

The development of new automated machinery for the production of minivans is an improvement in technology. This reduction in firms’ costs will result in an increase in supply. Demand is not affected. The result is a decline in the price of minivans and an increase in the quantity sold, as Figure 14 shows.

Question 17

Consider the market for minivans. For each of the events listed here, identify which of the determinants of demand or supply are affected. Also indicate whether demand or supply increases or decreases. Then draw a diagram to show the effect on the price and quantity of minivans. - The price of sports utility vehicles rises.

Answer 17

The rise in the price of sport utility vehicles affects minivan demand because sport utility vehicles are substitutes for minivans. The result is an increase in demand for minivans. Supply is not affected. The equilibrium price and quantity of minivans both rise, as Figure 12 shows.

Question 18

Consider the market for minivans. For each of the events listed here, identify which of the determinants of demand or supply are affected. Also indicate whether demand or supply increases or decreases. Then draw a diagram to show the effect on the price and quantity of minivans. - A stock market crash lowers people’s wealth.

Answer 18

The reduction in peoples’ wealth caused by a stock-market crash reduces their income, leading to a reduction in the demand for minivans, because minivans are likely a normal good. Supply is not affected. As a result, both the equilibrium price and the equilibrium quantity decline, as Figure 15 shows.

Question 19

Consider the market for DVDs, TV screens, and tickets at movie theaters. For each pair, identify whether they are complements or substitutes: DVDs and TV screens DVDs and movie tickets TV screens and movie tickets

Answer 19

DVDs and TV screens are likely to be complements because you cannot watch a DVD without a television. DVDs and movie tickets are likely to be substitutes because a movie can be watched at a theater or at home. TV screens and movie tickets are likely to be substitutes for the same reason.

Question 20

Consider the market for DVDs, TV screens, and tickets at movie theaters. Suppose a technological advance reduces the cost of manufacturing TV screens. Draw a diagram to show what happens in the market for TV screens.

Answer 20

The technological improvement would reduce the cost of producing a TV screen, shifting the supply curve to the right. The demand curve would not be affected. The result is that the equilibrium price will fall, while the equilibrium quantity will rise. This is shown in Figure 16.

Question 21

Consider the market for DVDs, TV screens, and tickets at movie theaters. Draw two more diagrams to show how the change in the market for TV screens affects the markets for DVDs and movie tickets.

Answer 21

The reduction in the price of TV screens would lead to an increase in the demand for DVDs because TV screens and DVDs are complements. The effect of this increase in the demand for DVDs is an increase in both the equilibrium price and quantity, as shown in Figure 17.

Question 22

Over the past 30 years, technological advances have reduced the cost of computer chips. How do you think this has affected the market for computers? For computer software? For typewriters?

Answer 22

Technological advances that reduce the cost of producing computer chips represent a decline in an input price for producing a computer. The result is a shift to the right in the supply of computers, as shown in Figure 19. The equilibrium price falls and the equilibrium quantity rises, as the figure shows.

Question 23

Using the supply and demand diagrams, show the effect of the following events on the market for sweatshirts. A hurricane in South Carolina damages the cotton crop.

Answer 23

When a hurricane in South Carolina damages the cotton crop, it raises input prices for producing sweatshirts. As a result, the supply of sweatshirts shifts to the left, as shown in Figure 22. The new equilibrium price is higher and the new equilibrium quantity of sweatshirts is lower.

Question 24

Using the supply and demand diagrams, show the effect of the following events on the market for sweatshirts. The price of leather jackets falls.

Answer 24

A decline in the price of leather jackets leads more people to buy leather jackets, reducing the demand for sweatshirts. The result, shown in Figure 23, is a decline in both the equilibrium price and quantity of sweatshirts.

Question 25

Using the supply and demand diagrams, show the effect of the following events on the market for sweatshirts. All colleges require morning exercise in appropriate attire.

Answer 25

The effects of colleges requiring students to engage in morning exercise in appropriate attire raises the demand for sweatshirts, as shown in Figure 24. The result is an increase in both the equilibrium price and quantity of sweatshirts.

Question 26

Using the supply and demand diagrams, show the effect of the following events on the market for sweatshirts. New knitting machines are invented.

Answer 26

The invention of new knitting machines increases the supply of sweatshirts. As Figure 25 shows, the result is a reduction in the equilibrium price and an increase in the equilibrium quantity of sweatshirts.

Question 27

A survey shows an increase in drug use by young people. In the ensuing debate, two hypotheses are proposed: - Reduced police efforts have increased the availability of drugs on the street.

Answer 27

Reduced police efforts would lead to an increase in the supply of drugs. As Figure 26 shows, this would cause the equilibrium price of drugs to fall and the equilibrium quantity of drugs to rise.

Question 28

A survey shows an increase in drug use by young people. In the ensuing debate, two hypotheses are proposed: - Cutbacks in education efforts

Answer 28

On the other hand, cutbacks in education efforts would lead to a rise in the demand for drugs. This would push the equilibrium price and quantity up, as shown in Figure 27.

Question 29

Suppose that in the year 2015 the number of births is temporarily high. How does this baby boom affect the price of babysitting services in 2020? (Hint: 5-year olds need babysitters, whereas 15 year olds can be babysitters.)

Answer 29

In the year 2020, there are more five-year-olds who need sitters, so the demand for baby-sitting services rises, as shown in Figure 28.

Question 30

Suppose that in the year 2015 the number of births is temporarily high. How does this baby boom affect the price of babysitting services in 2030? (Hint: 5-year olds need babysitters, whereas 15 year olds can be babysitters.)

Answer 30

However, in the year 2030, the increased number of 15-year-olds shifts the supply of baby-sitting services to the right, as shown in Figure 29. The result is a decline in the price of baby-sitting services.

Question 31

Ketchup is a complement (as well as a condiment) fot hot dogs. If the price of hot dogs rises, what happens to the market for ketchup? For tomatoes? For tomato juice? For orange juice?

Answer 31

Ketchup is a complement for hot dogs. Therefore, when the price of hot dogs rises, the quantity demanded of hot dogs falls and this lowers the demand for ketchup. The end result is that both the equilibrium price and quantity of ketchup fall. Because the quantity of ketchup falls, the demand for tomatoes by ketchup producers falls, so the equilibrium price and quantity of tomatoes fall. When the price of tomatoes falls, producers of tomato juice face lower input prices, so the supply curve for tomato juice shifts out, causing the price of tomato juice to fall and the quantity of tomato juice to rise. The fall in the price of tomato juice causes people to substitute tomato juice for orange juice, so the demand for orange juice declines, causing the price and quantity of orange juice to fall. Now you can see clearly why a rise in the price of hot dogs leads to a fall in the price of orange juice!

Question 32

The market for pizza has the following demand and supply schedule. Graph the demand and supply curves. What is the equilibrium price and quantity in this market?

Answer 32

Quantity supplied equals quantity demanded at a price of $6 and quantity of 81 pizzas (Figure 30).

Question 33

The market for pizza has the following demand and supply schedule. If the actual price in this market were below the equilibrium price, what would drive the market toward the equilibrium?

Answer 33

If the price were less than $6, quantity demanded would exceed quantity supplied, so suppliers could raise the price without losing sales. In both cases, the price would continue to adjust until it reached $6, the only price at which there is neither a surplus nor a shortage.

Question 34

Consider the following events: Scientists reveal that consumptions of oranges decreases the risk of diabetes, and at the same time, farmers use a new fertilizer that makes orange trees more productive. Illustrate and explain what effect these changes have on the equilibrium price and quantity of oranges.

Answer 34

The news of the increased health benefits from consuming oranges will increase the demand for oranges, increasing both the equilibrium price and quantity. If farmers use a new fertilizer that makes orange trees more productive, the supply of oranges will increase, leading to a fall in the equilibrium price but a rise in the equilibrium quantity. If both occur at the same time, the equilibrium quantity will definitely rise, but the effect on equilibrium price will be ambiguous.

Question 35

Because bagels and cream cheese are often eaten together, they are complements. We observe that both the equilibrium price of cream cheese and the equilibrium quantity of cream cheese and the equilibrium quantity of bagles have risen. What could be responsible for this pattern - a fall in the price of flour or a fall in the price of milk? Illustrate and explain your answer.

Answer 35

Because flour is an ingredient in bagels, a decline in the price of flour would shift the supply curve for bagels to the right. The result, shown in Figure 31, would be a fall in the price of bagels and a rise in the equilibrium quantity of bagels.

Question 36

Because bagels and cream cheese are often eaten together, they are complements. We observe that both the equilibrium price of cream cheese and the equilibrium quantity of cream cheese and the equilibrium quantity of bagles have risen. What could be responsible for this pattern - a fall in the price of flour or a fall in the price of milk? Illustrate and explain your answer.

Answer 36

Because cream cheese is a complement to bagels, the fall in the equilibrium price of bagels increases the demand for cream cheese, as shown in Figure 32. The result is a rise in both the equilibrium price and quantity of cream cheese. So, a fall in the price of flour indeed raises both the equilibrium price of cream cheese and the equilibrium quantity of bagels.

Question 37

Because bagels and cream cheese are often eaten together, they are complements. We observe that both the equilibrium price of cream cheese and the equilibrium quantity of cream cheese and the equilibrium quantity of bagles have risen. What would happen with a fall in the price of milk?

Answer 37

What happens if the price of milk falls? Because milk is an ingredient in cream cheese, the fall in the price of milk leads to an increase in the supply of cream cheese. This leads to a decrease in the price of cream cheese (Figure 33), rather than a rise in the price of cream cheese. So a fall in the price of milk could not have been responsible for the pattern observed.

Question 38

Because bagels and cream cheese are often eaten together, they are complements. Suppose instead that the equilibrium price of cream cheese has risen but the equilibrium quantity of bagels has fallen. What could be responsible for this pattern - a rise in the price of flour or a rise in the price of milk? Illustrate and explain your answer.

Answer 38

In part (a), we found that a fall in the price of flour led to a rise in the price of cream cheese and a rise in the equilibrium quantity of bagels. If the price of flour rose, the opposite would be true; it would lead to a fall in the price of cream cheese and a fall in the equilibrium quantity of bagels. Because the question says the equilibrium price of cream cheese has risen, it could not have been caused by a rise in the price of flour. What happens if the price of milk rises? From part (a), we found that a fall in the price of milk caused a decline in the price of cream cheese, so a rise in the price of milk would cause a rise in the price of cream cheese. Because bagels and cream cheese are complements, the rise in the price of cream cheese would reduce the demand for bagels, as Figure 34 shows. The result is a decline in the equilibrium quantity of bagels. So a rise in the price of milk does cause both a rise in the price of cream cheese and a decline in the equilibrium quantity of bagels.

Question 39

Suppose that the price of basketball tickets at your college is determined by market forces. Currently, the demand and supply schedules are in the following table. Draw the demand and supply curves. What is unusual about this supply curve? Why might this be true?

Answer 39

As Figure 35 shows, the supply curve is vertical. The constant quantity supplied makes sense because the basketball arena has a fixed number of seats at any price.

Question 40

Suppose that the price of basketball tickets at your college is determined by market forces. Currently, the demand and supply schedules are in the following table. What are the equilibrium price and quantity of tickets?

Answer 40

Quantity supplied equals quantity demanded at a price of $8. The equilibrium quantity is 8,000 tickets.

Question 41

Market research has revealed the following information about the market for chocolate bars: The deamnd schedule can be represented by the equation .... Qd = 1600 - 300P, where Qd is the quantity demanded and P is the price. The supply schedule can be represented by the equation.... Qs = 1400 + 700P, where Qs is the quantity supplied. Calculate the equilibrium price and quantity in the market for chocolate bars.

Answer 41

Equilibrium occurs where quantity demanded is equal to quantity supplied. Thus: Qd = Qs 1,600 – 300P = 1,400 + 700P 200 = 1,000P P = $0.20 Qd = 1,600 – 300(0.20) = 1,600 – 60 = 1,540 Qs = 1,400 + 700(0.20) = 1,400 + 140 = 1,540. The equilibrium price of a chocolate bar is $0.20 and the equilibrium quantity is 1,540 bars.