Part 2 [Supply and Demand I: How Markets Work] - 4. the market forces of supply and demand - 5.elasticity and its application - 6. supply, demand, and government policies Flashcards
(104 cards)
1
Q
What is a Market?
A
A group of buyers and sellers of a particular good or service.
2
Q
How are markets generally organized?
A
Sometimes markets are highly organized. More often, markets are less organized.
3
Q
What is a competitive market?
A
A market in which there are many buyers and many sellers so that each has a negligible impact on the market price.
4
Q
How is price and quantity determined by all buyers and sellers in a competitive market?
A
Each buyers knows that there are several sellers to chose from,and each seller is aware that his product is similar to that offered by other sellers.
5
Q
What is a perfectly competitive market?
A
- The goods offered for sale are exactly the same.
- The buyers and sellers are so numerous that no single buyer or seller has any influence over the market price.
6
Q
Why are buyers and seller in a perfectly competitive market price takers?
A
Because they must accept the market price.
7
Q
Why is it good to study perfectly competitive markets?
A
- They’re the easiest to analyze because everyone is a price taker.
- Because some degree of competition is present in most markets, many of the lessons that we learn by studying suppy and demand under perfect competition apply in more complicated markets as well
8
Q
What is quantity demanded?
A
The amount of a good that buyers are willing and able to purchase.
9
Q
What is the law of demand?
A
The claim that, other things equal, the quantity demanded of a good falls as the price rises.
Qd is negatively related to P
10
Q
What is a demand schedule?
A
A table that shows the relationship between the price of a good and the quantity demanded.
11
Q
What is a demand curve and how is it traditionally organized?
A
A graph of the relationship between the price of a good and the quantity demanded.
P on Y-axis Qd on X-axis.
12
Q
What is market demand, how is it calculated and how is it expressed on graphs?
A
The sum of all individual demand for a particular good or service.
Sum the individual demand curves horizontally.
13
Q
What 5 things could cause a demand curve to shift?
A
- Change in Income
- Price of Substitutes
- Price of Compliments
- Tastes
- Expectations
14
Q
How would an increase or decrease in demand/supply shift a demand/supply curve?
A
Shift right for increase
Shift left for decrease
15
Q
What is a normal good?
A
A good for which, other things equal, an increase in income leads to an increase in demand.
16
Q
What is an inferior good?
A
A good for which, other things equal, an increase in income leads to a decrease in demand.
17
Q
What is the wealth effect and how does it affect a demand curve?
A
The impact of changes in wealth on both the amount and composition of goods that the individual consumes.
It can shift the demand curve much like changes in income can.
18
Q
What are substitutes?
A
Two goods for which an increase in the price for one leads to an increase in demand for the other.
19
Q
What are compliments?
A
Two goods for which an increase in the price for one leads to an decrease in demand for the other.
20
Q
What are two examples of how expectation could affect demand?
A
- If you expects a higher income next month, you may be more willing to spend some of your current savings.
- If you expect the price of a good to fall tomorrow, you may be less willing to buy the good today.
21
Q
How would the number of buyers affect demand?
A
Increase = Shift right Decrease = Shift left
22
Q
In summary, what shifts demand curves?
A
A change in a variable other than price.
23
Q
What are two ways policy makers try to get people to quit smoking? Qd(before)>Qd(after)
A
- Shift demand curve: Advertise to impact tastes and possibly expectations.
- Raise Price: Tax
24
Q
What is quantity supplied?
A
The amount of a good that sellers are willing and able to sell.
25
What is the law of supply?
The claim that, other things equal, the quantity supplied of a good rises when the price of the good rises.
26
What is a supply schedule?
A table that shows the relationship between the price of a good and the quantity supplied.
27
What is a supply curve?
A graph of the relationship between the price of a good and the quantity supplied.
28
What is market supply, how is it calculated and how is it expressed on graphs?
The sum of all individual supply for a particular good or service.
Sum the individual supply curves horizontally.
29
What 4 things could cause a supply curve to shift?
- Input prices
- Technology
- Expectations
- Number of sellers
30
How is the supply of a good related to the price of the inputs used to make it?
Negatively
31
How would a change in technology affect supply?
By reducing firms' costs, an advance in technology raises supply.
32
What is an examples of how expectation could affect supply?
If a firm expects the price of a good to rise in the future, it will put some of its current production into storage and supply less to the market today.
33
How would the number of sellers affect supply?
```
Increase = Shift right
Decrease = Shift left
```
34
What is equilibrium in economics?
A situation in which the price has reached a level where the Qs equals Qd.
35
What is the equilibrium price?
The price that balances Qd and Qd
36
What is the equilibrium quantity.
The Qs and the Qd at the equilibrium price.
37
What else is the equilibrium price sometimes called and why?
The Market Clearing Price, because, at this price, everyone in the market has been satisfied.
38
What is surplus, and what is it sometimes called?
A situation of Exess Supply, in which Qs > Qd
39
What is a shortage?
A situation of Exess Demand in which Qs < Qd
40
What is the law of supply and demand?
The claim that the price of any good adjusts to bring the Qs and the Qd for that good into balance.
41
What is comparative statics?
The analysis of how the equilibrium in the market changes when some event shifts Qs or Qd.
42
What are the three steps of comparative statics?
1. Decide whether the event shifts the Qs or Qd (or both)
2. Decide in which direction it shifts
3. Use the supply-and-demand diagram to see how the shift changes the equilibrium price and quantity.
43
What is the difference between a change in supply/demand and a change in the quantity supplied/demanded?
A change in supply/demand is a shift in the supply/demand curve.
A change in the quantity supplied/demanded is a movement along a fixed supply/demand curve.
44
In summary, how does price act in a market economy?
Prices are the mechanism for rationing scarce resources. Similarly, prices determine who produces each good and how much is produced.
45
What is elasticity?
A measure of the responsiveness of Qd or Qs to one of its determinants.
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What is price elasticity of demand and how is it computed?
A measure of how much the Qd responds to a change in P, computed as ε = (%ΔQd)/(%ΔP)
47
When is demand for a good said to be elastic?
If the Qd responds substantially to ΔP.
48
When is demand for a good said to be inelastic?
If Qd responds only slightly to ΔP.
49
What are the four general rules which determine the price elasticity of demand?
1. Availability of close substitutes.
2. Necessities vs. luxuries.
3. Definition of the market.
4. Time horizon
50
Why do goods with close substitutes tend to have more elastic demand?
Because it's easier for consumers to switch from that good to others.
51
How are the elasticities of necessities and luxuries?
- Necessities tend to have inelastic demand.
| - Luxuries tend to have elastic demands.
52
What determines whether a good is a necessity or luxury?
The preferences of the buyer.
53
Why do narrowly defined markets tend to have more elastic demand than broadly defined markets?
Because it is easier to find close substitutes for narrowly defined goods.
54
How does elasticity of demand typically work over time?
Goods tend to have more elastic demand over longer time horizons.
55
Why is it common practice to drop the minus sign and reporting all elasticities in absolute terms?
Because the Qd of a good is negatively related to its P (law of demand), the %ΔQd will always have the opposite sign as the %ΔP.
56
Why is the midpoint method often used to calculate elasticities?
Because the midpoint method gives the same answer regardless of the direction of change between points.
57
What is the general formula for the midpoint method of finding elasticities?
ε = (Q2-Q1)/[(Q2+Q1)/2]/(P2-P10/[(P2+P1)/2]
58
When is demand elastic and what does it mean for demand to be elastic?
When ε>1.
| Qd moves proportionately more than P.
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When is demand inelastic and what does it mean for demand to be inelastic?
When ε<1
| Qd moves proportionately less than P.
60
When does demand have unit elasticity and what does it mean for demand to have unit elasticity?
When ε=1
| Qd moves the same amount proportionately to P.
61
How does the slope of a demand curve say about its elasticity?
The flatter the demand curve that passes through a given point, the greater the price elasticity of demand.
The steeper the curve that passes through a given point, the smaller the price elasticity of demand.
62
What is a good memory trick for remembering visual representations of elasticity and inelasticity?
Think of I for inelastic (vertical)
| Think of E for elastic (horizontal)
63
What is total revenue and how is it computed?
The amount paid by buyers and received by sellers of a good, computed as the P x Qd
64
How is total revenue at a specific P and Qd shown graphically.
The area of the box to left of and below the point.
| The area of the box with height equal to P and width equal to Qd.
65
How does total revenue change as one moves along the demand curve?
- If demand is inelastic, an increase in P causes an increase in total revenue. (P&TR same direction)
- If demand is elastic, an increase in P causes a decrease in total revenue. (P&TR opposite direction)
- If demand is unitary elastic, a change in P has no effect on total revenue.
66
Why does an increase in P increase total revenue when demand is inelastic?
An increase in P raises PxQd because the fall in Qd is proportionately smaller than the rise in P.
67
Why does an increase in P decrease total revenue when demand is elastic?
An increase in P reduces PxQd because the fall in Qd is proportionately greater than the rise in P.
68
Why isn't the elasticity constant along a linear demand curve if the slope is?
The slope is the ratio of changes in the two variables, whereas the elasticity is the ratio of percentage changes in the two variables.
69
On a linear demand curve, which sections are more or less elastic?
At points with a low price and high quantity, the demand curve is inelastic.
At points with a high price and low quantity, the demand curve is elastic.
70
What is the income elasticity of demand and how is it computed?
A measure of how much Qd of a good responds to a change in consumers' income, computed as ξ(xi) = (%ΔQd)/(%ΔIncome)
71
How are the income elasticities of normal goods?
Normal goods have positive income elasticities.
72
How are the income elasticities of inferior goods?
Inferior goods have negative income elasticities.
73
What are the income elasticities of necessities and why?
Necessities have tend to have small income elasticities because, regardless of how low their income, consumers choose to buy some of these goods.
74
What are the income elasticities of luxuries and why?
Luxuries tend to have large income elasticities because consumers feel that they can do without these goods altogether if their income is low.
75
What is cross-price elasticity and how is it computed?
A measure of how much Qd of one good responds to ΔP of another good, computed as (%ΔQd1)/(%ΔP2).
76
What is the cross-price elasticity of substitutes and why?
Substitutes have a positive cross-price elasticity because Qd1 and P2 move in the same direction
77
What is the cross-price elasticity of compliments and why?
Compliments have a negative cross-price elasticity because Qd1 and P2 move in the opposite direction
78
What is price elasticity of supply and how is it computed?
A measure of how much Qs responds to a ΔP, computed as η(eta) = (%ΔQs)/(%ΔP)
79
When i supply for a good said to be elastic?
If the Qs responds substantially to ΔP.
80
When i supply for a good said to be inelastic?
If the Qs responds onyl slightly to ΔP.
81
Why is supply usually more elastic in the long run than in the short run?
The price elasticity of supply depends on the flexibility of sellers to change the amount of the good they produce.
Over short periods of time, firms cannot easily change the size of their factories to make more or less of a good.
Over longer periods, firms can build new factories, close old ones, enter a market or leave a market.
82
Explain how a typical supply curve (bowed) and its varying elasticities could be interpreted anecdotally.
In certain industries, firms have factories with a limited capacity for production. For low levels of Qs, η is high, indicating that firms respond substantially to changes in P. In this region, firms have capacity for production that is not being used, such as plants and equipment sitting idle for all or part of the day. Small increases in price make it profitable for firms to begin using this idle capacity. As Qs rises, firms begin to reach capacity. Once capacity is fully used, increasing production further requires the construction of new plants. to induce firms to incur this extra expense, P must rise substantially, so supply becomes less elastic.
83
Imagine researchers devised a new hybrid of wheat that raises by 20% the amount that farmers can produce from each hectare of land. What is this an example of and does this discovery make farmers better or worse off?
This is an example of wheat farmers increasing their productivity given new available technology.
Because the hybrid increases the amount of wheat that can be produced on each hectare of land, farmers are now willing to supply more wheat at any given price (supply shifts right, demand remains the same). This hybrid allows farmers to increase Qs but now P falls.
Because wheat consumption is relatively inelastic, a decrease in P leads to lower total revenue.
84
If farmers are made worse off by the discovery this new hybrid, why do they adopt it?
They're price takers.
Because each farmer is a small part of the market for wheat, he or she takes the price of wheat as given. For any P, it is better to use the new hybrid in order to produce and sell more wheat.
85
Explain why, unlike their predecessors, most Canadians today are no longer farming.
Over time, advances in farm technology increased the amount of food that each farmer could produce. This increase in food supply, together with inelastic food demand, caused farm revenue to fall, which in turn encouraged people to leave farming. Since Canadians today eat at least as well as they did in the past, this decrease in the proportion of Canadians working in agriculture represents a tremendous increase in farm productivity.
86
How does this analysis of the market for farm products explain why certain farm programs try to restrict the amount of milk and eggs that farmers are allowed to produce?
Their purpose is to reduce Qs thereby raising P. Because Qd is inelastic,farmers as a group receive greater total revenue.
No single farmer would choose to restrict supply on his own, since each takes the market price as given.
87
When analyzing the effects of farm technology or farm policy, what should you to keep in mind?
Improvement in farm technology can be bad for farmers who become increasingly unnecessary, but it is good for consumers who pay less for food.
88
What does the OPEC episode of the 1970's and 1980's show us?
How supply and demand can behave differently in the short run and the long run. Over the short run, both demand and supply are inelastic. Over the long run, both demand and supply are elastic.
89
What is the main takeaway from the case study on drug interdiction?
- Prohibition increases P and indeed leads to a reduction in Qs and therefore the amout of drugs consumed.
- But because short run Qd is inelastic, a raise in price leads to higher total revenue in the drug market, enticing more drug dealers to enter the market and enticing drug users to go to greater lengths to get the money to pay higher prices, leading to an overall increase in drug-related crime.
- Over the long run Qd may be elastic as higher prices lead fewer people to experiment with the drugs.
- By reducing Qd (with drug education programs) policymakers could reduce drug consumption as well as the associated violence instead of trading off consumption for violence.
90
What is a price ceiling?
A legal maximum on the price at which a good can be sold.
91
What is a price floor?
A legal minimum on the price at which a good can be sold.
92
When is a price ceiling binding?
When the equilibrium price is above the price ceiling.
93
When is a price floor binding?
When the equilibrium price is below the price floor.
94
What emerges as a result of a binding price ceiling?
A shortage.
95
What emerges as a result of a binding price floor?
A surplus.
96
What caused long line-ups at the pumps when OPEC acted up?
Shortages due to government imposed price ceilings on gasoline prices.
97
What is the usual effect of a shortage due to rent control?
Landlords lose their incentive to respond to tenants' concerns. Why should a landlord spend his money to maintain and improve his property when people are waiting to get in as it is?
98
What is an important example of a price floor?
Minimum wage
99
How does minimum wage affect workers differently?
The impact of the minimum wage depends on the skill and experience of the worker.
Workers with high skills and much experience are not affected, because the minimum wage isn't binding; their equilibrium wages are well above the minimum.
Teenagers and unskilled workers are affected by the binding minimum wage laws. More workers want to work, less firms want to hire.
100
What is a tax incidence?
The manner in which the burden of a tax is shared among participants in a market.
101
Explain the tax incidence when a tax is imposed on buyers or when it is imposed on sellers.
Taxes on buyers and taxes on sellers are equivalent.
In both cases, the tax places a wedge between the price that buyers pay and the price that sellers receive. The wedge between the buyers' price and the sellers' price is the same regardless of whether the tax is levied on buyers or sellers.
102
Which side bears most of the tax incidence?
A tax burden falls more heavily on the side of the market that is less elastic.
103
Why does a tax burden fall more heavily on the side of the market that is less elastic?
A small ε means that buyers don't have good alternatives to consuming this particular good. A small η means that sellers do not have good alternatives to producing this particular good.
When the good is taxed, the side of the market with fewer good alternatives cannot easily leave the market and must bear most of the tax burden.
104
What are the two controls on price?
A price ceiling and a price floor.
