Theme 2.1: Part 1 - The interaction of Demand and SupplyDemand

Question 1

Define “Demand”

Answer 1

Demand is defined as the quantity of a good that consumers are willing and able to purchase at a given time period at every price level, ceteris paribus

Question 2

Define “Quantity demanded”

Answer 2

Quantity demanded is defined as the quantity of a good that consumers are willing and able to purchase at a given time period at a given price point, ceteris paribus

Question 3

Define “The law of Demand”

Answer 3

The law of demand states that when the price of a good rises, its quantity demanded will fall and vice versa, ceteris paribus

Question 4

Define “The law of diminishing marginal utility”

Answer 4

The law of diminishing marginal utility states that beyond a certain point of consumption, as more and more units of a good or service is consumed, the additional utility a consumer derives from successive units decreases

Question 5

How can it be illustrated on the demand curve when the price of the good increases

Answer 5

There will be a decrease in quantity demanded, hence a upward movement along the demand curve

Question 6

State the non-price determinants of demand

Answer 6

Expected change in price
Exchange rates
Ease of credit
Government policies
Yincome
Population
Price of related goods
Taste and perferences

Question 7

How would an expected change in price affect demand?

Increase in price decreases demand + Decrease in price increase demand

Answer 7

When price of a good is expected to rise in the future, comsumers are more likely to hold back their purchase, causing the demand now to decrease, ceteris paribus

Wen the price of a good is expected to drop in the future, consumers are more likely to bring forward their purchase, causing the demand now to increase, ceteris paribus

Question 8

How does exchange rate affect demand

Appreciation + Depreciation

Answer 8

An appreciation of **domestic currency **makes imported substitutes relatively cheaper, decrease demand for locally produced goods

A depreciation of **domestic currency **makes imported substitutes relatively more expensive, increase demand for locally produced goods

Question 9

How does ease of credit affect demand

Lower Interest rate + Higher interest rate

Answer 9

Lower interest rates, Lower cost of borrowing, encouraing borrowing for consumption, increasing affordability, increaseing demand

Higher interest rates, Higher cost of borrowing, discouraging borrowing for consumption, decreases affordability, decreasing demand

Question 10

How does government policies affect demand

Eg. Ban/Quota

Answer 10

Ban decreases consumption and sale, decreasing demand

Question 11

How does level of income affect demand

Rise in income + Fall in income

Answer 11

ASSUMING THE GOOD IS A NORMAL GOOD
Rise in level of income increases purchasing power, increasing one’s willingness and ability to purchase a good/service, increasing demand

Fall in level of income decreases purchasing power, decreasing one’s willingness and ability to purchase a good/service, decreasing demand

if good is inferior, rise in income would decrease demand. vice versa

Question 12

Explain the difference between economic slowdown and economic recession, and how each affects demand

Answer 12

Economic slowdown → Economy still improving but at a slower rate, income increasing at a slower rate
1. Demand for good increases at a slower rate
2. Demand decreases as future income and purchasing power are expected to fall

Economic recession → Economy getting worse, income remains stagnant/decrease
1. Demand decrease due to lower purchasing power, decrease in ability to purchase goods and services

Question 13

How does population size affect demand

Rise in population size + Fall in population size

Answer 13

Rise in population size increases demand

Fall in population size decreases demand

Could also lead to a change in population structure

Question 14

Define “Substitutes”

Answer 14

Substitutes are goods which are considered to be alternatives to each other. Substitutes are in competitive demand

Question 15

Define “Complements”

Answer 15

Complements are goods that when consumed together, give rise to a higher combined utility than if the goods were consumed individually. Complements are in joint demand

Question 16

Define “Derived Demand”

Answer 16

The demand for goods which are not demanded for its own sake but is used to facilitate the production of another

Question 17

How does change in price of related goods affect demand

Substitute + Complementary + Derived Demand

Answer 17

Substitutes
* Price of substitutes increase, consumers would turn to cheaper alternative of the good, increasing demand for the good
* Price of substitute decreases, consumers would turn to cheaper substitute, decreasing demand for the good

Complements
* Price of complement increases, **quantity demanded of complement **falls, the demand for the good of interest to fall
* Price of complement decreases, **quantity demanded of complement **rises, demand for good of interest to rise.

Derive demand:
* Since a good is a factor of production of the good of interest, when the demand for good increases, the demand for the good of interest increases too, ceteris paribus.

Question 18

How change in taste and preference affect demand

Favourable change + Unfavourable change

Answer 18

Favourable change in taste and preference can cause consumer to be more willing to purchase the good, increasing demand

Unfavourable change in taste and preference can cause consumer to be less willing to purchase the good, decreasing demand

Question 19

Define “Supply”

Answer 19

Supply is defined as the quantity of a good a producer is willing and able to sell in a given time period at every price level, ceteris paribus

Question 20

Define “Quantity supplied”

Answer 20

Quantity supplied is defined as the quantity of a good a producer is wiliing and able to sell in a given time period at a given price point, ceteris paribus

Question 21

Define “Law of supply”

Answer 21

The law of supply states that as the price of a good rises, quantity supplied of the good rises and vice versa, ceteris paribus

Question 22

How can it be illustrated on the supply curve when the price of the good increases

Answer 22

Quantity supplied increases, hence there is a upward movment along the supply curve

Question 23

State the non-price determinants of supply

Answer 23

Expected change in price
Governmnt policies
Supply shock
Price of related goods
Productivity
Input Prices
Number and size of firms

Question 24

How would an expected change in price affect supply

Answer 24

If price of good is expected to rise, producers would temporarily hold back their stocks and sell them at a higher price in the future to increase revenue and hence profit. Supply decreases

If price of good is expected to fall, producers will bring forward the sale of the good and sell them at the highest price now to increase revenue and hence profit. Supply increases

Question 25

How does government policies affect supply

Tax + Subsidy

Answer 25

Tax is imposed, cost of production increases, production less profitable, supply decreases

Subsidy is granted, cost of production decreases, production more profitable, supply increases

Question 26

How does supply shock affect demand

Answer 26

Supply shock such as disasters decreases the ability to sell the good/service, decreasing supply

(Supply shock such as an unexpected harvest may increase ability to sell the good/service, increasing supply)

Question 27

Define “Joint Supply”

Answer 27

Good are in joint supply when the production of one leads to the production of the other good

Question 28

Define “Competitive Supply”

Answer 28

Good are in competitive supply when they compete for the use of the same inputs

Question 29

How does a change in price of related good affect supply

Goods in joint supply + Goods in competitive supply

Answer 29

Joint supply
The increase in production of one good increase the quantity supplied of the good, hence increasing supply for the other
The decrease in production of one good decreases the quantity supplyed for the good, hence decreasing supply for the other

Competitive supply
The increase in price of one good would lead to quantity supplied of that good to increase since it is more profitable to do so. More resources are diverted to produce this good and lesser resources are avaliable for the production other. Supply of the other good decreases.

Question 30

How does productivity affect supply

Answer 30

Increase in productivity allows for more output to be produced with the same given input. **Cost of production **is lowered, production is more profitable, producers more willing and able to produce, supply increases

Question 31

How does a change in input prices affect supply

Answer 31

Increase in input prices increases cost of prouduction. Production is less profitable, producers less **willing and able **to produce, supply decreases

Decrease in input prices decreases cost of prouduction. Production is more profitable, producers more **willing and able **to produce, supply increases.

Question 32

How does number and size of firms affect supply

Answer 32

Increase in number causes supply for the good to increase
Increase in size of firm increases capacity of industry, and hence supply of the good

Question 33

Describe the market adjustment process

Draw a double shift diagram to aid with the explanation

Draw market for eggs. Chickens dying due to virus + economic slowdown

Answer 33

1. Factors of demand and supply involved (+ extent of shift)
2. At initial price point
   * quantity demanded > quantity supplied, shortage of (Qd - Qs) units
   * quantity supplied > quantity demanded, surplus of (Qs - Qs) units
3. Upward pressure/Downward pressure on price
4. Effect of price on quantity demanded and quantity supplied
   * Shortage → increase in price: quantity demanded decreases, quantity supplied increases to eliminate the shortage
   * Surplus → decrease in price: quantity demanded increases, quantity supplied decreases to eliminate the surplus
5. State changes in equilibrium quantity and equilibrium price (increase/decrease/indeterminate)

Question 34

Explain the signalling function of price

Answer 34

Signal to consumers and producers whether to enter of leave a market
* Rising prices signal to consumers to reduce quantity demanded or withdraw themselves from market completely, signal producers to enter a market
* Falling prices signals consumers to enter a market (positive message) while sending a signal to producers to leave a market (negative signal)

Question 35

Explain the incentive function of price

Answer 35

Motivates producers or consumer to follow a course of action or to change behavior as it increases their welfare
* When price decrease, consumers has the incentive to buy more, increasing consumption, hence welfare
* When prices increase, producers are incentiviced to sell more due to higher potential profits which can raise profit and hence welfare

Question 36

Explain the allocative function of price

Answer 36

Prices direct producers to allocate resources away from overcrowded markets, where there are surpluses and towards market that are underserved, where there are shortages

Question 37

Explain the rationing function of price

Answer 37

Price ration goods and services to consumers who are** most willing and able to pay for them**
* Shortage → consumers bid up the price of it, only those who are able and willing to pay for them remain in the market while those who are unable and unwilling will drop out. Hence Shortages are rationed