Module 2

Question 1

Concept of demand

What is “the law of demand”?

Answer 1

States quantity of a good demanded per period of time will fall as price rises and rise as price falls (other things being equal).
This is due to income and substitute effects.

Question 2

What is the “income effect”?

Answer 2

Income effect is the effect of a change in price on quantity demanded (how much consumer can and will buy), stemming from the consumer becoming better or worse off as a result of the price change.

E.g. good price goes down, consumer has more real income to spend (increases), allows them to purchase more of the good or other goods.

Question 3

What is the “substitution effect”?

Answer 3

Effect of a change in price on quantity demanded (how much consumer can and will buy) stemming from the consumer switching to or from an alternative (substitute) product.

Describes how consumers shift their spending to less expensive alternatives when the price of a product increases, while keeping their income constant, or vice versa.

Question 4

What is “quantity demanded”?

Answer 4

Amount of a good the consumer is willing and able to buy at a given price over a given period of time.

Question 5

Demand curve for typical good and what it shows.

Answer 5

Inward curve high (1,y) to (x,1).
X = Quantity of good that would be demanded at each price (Y) over a given time period, assuming all other factors that determine demand are held constant.
Exponential, lower the price, higher quantity good demanded (person able and willing to buy) and vice versa.
Assuming all other factors that determine demand are held constant.

Question 6

Difference between change in demand and a change in quantity demanded.

Answer 6

Change in demand refers to shift in demand curve, occurs when determinants other than price changes.

Change in quantity demanded refers to a movement along the demand curve, occurs when there is a change in price. (Consumers able and willing to buy more or less at a given price, e.g. price of product decreases, consumers willing to buy more).

Question 7

Six factors that could cause demand curve to shift

Answer 7

1. Consumer tastes
2. Number and prices of substitute goods
3. Number and prices of complementary goods
4. Consumer incomes
5. Distribution of income (income spread amongst individuals/households in a population)
6. Expectations of future price changes.

Decrease in demand = Shift left = Lower quantity demanded for given price.
Increase in demand = Shift right = Higher quantity demanded for given price.

Complementary = typically consumed together, increase one usually increases the other

Question 8

What are substitute goods?

Answer 8

Goods that consumers consider to be alternatives to each other. E.g. Two diff brands of bottled water, as price of one increases, demand for other (sub) increases (due to being lower price and acceptable sub).

Question 9

What are complementary goods?

Answer 9

Pairs of goods that are consumed together, e.g. Cars and Car Insurance. As the price of one goes up, the demand for both goods will fall. Demand increase for one will lead to demand increase for other.

Question 10

What are normal goods?

Answer 10

Goods for which demand rises as people’s incomes rise.
Most goods are normal goods.

Question 11

What are inferior goods?

Answer 11

Goods for which demand falls as people’s incomes rise. E.g. generic products, store brand, used cars (more money means better brands, new cars etc.)

Question 12

Supply curve for typical good and what it shows:

Answer 12

Outward curve, going up.
X is quantity of good (Q) that would be supplied at each price (P) over a given time period. Assumes all other factors that determine supply are held constant.

Question 13

Three reasons why quantity supplied will typically rise when price of a good rises:

Answer 13

1. A firms supply more, beyond a certain output level, costs are likely to rise more and more rapidly. It will only be worth it producing moe and incurring those higher costs if prices rise.
   (After a certain point, cost to produce (marginal cost?) is rapidly increasing, and is only worth continuing if price continues to rise).
2. The higher the price of a good, the more profitable it becomes to produce. Firms are encouraged to produce more by switching product lines from less profitable goods.
3. In long run, if price of good remains high, new firms will set up production - so market supply increases.

Question 14

Explain ‘substitutes in supply’ and ‘goods in joint supply’:

Answer 14

Subs in supply are two goods for which an increase in production in one involves diverting resources away from producing another e.g. Beef and Lamb

Goods in joint supply are goods for which the increased production of one leads to increased production of other.
(Can be applied to complementary goods)

Question 15

Explain ‘change in supply’ and ‘change in the quantity supplied’:

Answer 15

Change in supply refers to shift in supply curve, occurs when determinants other than the price changes. (Could be change in production costs, increase in suppliers).

Change in quantity supplied refers to a movement along a supply curve, occurs when there is a change in price.

This means that businesses are willing and able to supply a different quantity at a new price point, but the underlying production factors remain the same

Demand is consumer side, supply is producer/firm side.

Question 16

Shift vs Moving along the curve

Answer 16

Shift = Price changes samme, determinants other than price changes. Increase in supply/demand for a given price shifts right. Decrease in supply/demand at a given price shifts left.

Moving along = Business/Consumers willing and able supply/purchase goods at a different quantity at a new price point but underlying production factors do not change.

Question 17

Seven factors that could cause the supply curve to shift.

Answer 17

1. Costs of production (low costs, shift right)
2. Profitability of alternative products (substitutes in supply)
3. Profitability of goods in joint supply
4. Nature, random shocks and other unpredictable events, e.g. extreme weather, earthquakes.
5. Aim of producers e.g. maximising sales rather than profits.
6. Expectations of future price changes
7. Number of suppliers
   Left shift = decrease in supply. Right shift = increase in supply.

Create and refer to notes on how?

Question 18

Four main reasons for changes in the costs of production:

Answer 18

1. Changes in input prices e.g. wages (human labour), rent (buildings), raw material prices.
2. Changes in technology, e.g. faster PCs
3. Organisational changes within the firm, e.g. to achieve greater specialisation
4. Changes in government policy, e.g. with regard to taxes and subsidies on goods.

Question 19

Define Price Taker:

Answer 19

Firm (or person) that is unable to influence the market price. Instead must accept the market price as given.

Question 20

Define Market Clearing:

Answer 20

Market clears when supply matches demand, leaving no shortage or surplus.

Question 21

Demand and supply diagram showing equilibrium price and quantity for a typical good.
Describe market condition for there to be equilibrium and how it is restored if market is originally in disequilibrium.

Answer 21

• Market equilibrium occurs when demand equals supply.
• Excess supply (surplus) leads to price fall.
• Excess demand (shortage) leads to price rises.

Look at notes for graph.

Question 22

Diagrams to show equilibrium price and quantity of increase in demand and decrease in demand.

Answer 22

Refer to notes.
Increase in demand, price and quantity both rise.
Decrease in demand, price and quantity both fall.

is it quant demanded?

Question 23

Examples of financial incentives (2)

Answer 23

1. Consumers buy less of a good when its price (hence opportunity cost) rises.
2. Firms produce more of a good when its price rises as it is more profitable to do so.

Opportunity cost increases, e.g. buying £200 tablet, could have spent it on bills or something else. Is the cost of the product but that money can be used on something else. Trade off is not the money but the value/quality/what other product/goods/service you could have used it on.

Tablet, 200 vs 1000, opportunity cost are the value of the features I’m gaining by buying the more expensive tablet. I’m paying 800 more for features, if you go for cheaper, opportunity cost is losing out on features but saving 100. Trade off is features vs money.

Going down, the 200 has opportunity cost, could have spent it on groceries instead.
Don’t consider OC if item is made to seem essential.

Lower Paying Job (remote) vs Higher paying job (office), opportunity cost of picking the lower paying = extra income (because that’s what you’re giving up), opportunity cost of picking higher paying job = time (giving up extra time to travel to office). OC is what you are giving up when you pick one option over the other.

Question 24

Examples of non-financial incentives (3)

Answer 24

1. Charitable giving
2. Supporting a sports team
3. Buying presents for family members

Question 25

Examples of perverse incentives (2)

Answer 25

1. Making cars safer encourages people to drive faster. 2. Increasing income tax rates may make people work less, so that tax revenues fall. ## Footnote Another example, people have less regard for something if they know they are insured against it, may act in a less safe/more reckless manner.

Question 26

Diagrams to show equilibrium price and quantity of increase in supply and decrease in supply

Answer 26

Refer to notes. Increase in supply, price falls and quantity rises Decrease in supply, price rises and quantity falls | is it quant supplied?

Question 27

Explain the 'identification problem' Trouble of identifying demand and supply curves from limited data.

Answer 27

- Difficult to derive demand curve for a good from the evidence of price and quantity alone. - E.g. (i) High price, low quantity, (ii) Low price, high quantity. - We assume supply curve has shifted and that we have two points on the demand curve, however we cannot know whether or not the demand curve has also shifted due (due to changes in non-price determinants of demand), and if so, by how much. Equally, difficult to identify supply curve when the demand curve shifts, we cannot be sure whether change in price and quantity is due to entirely the shift in demand curve or whether supply curve has shifted too.