Topic 2: Demand and Supply Flashcards
(31 cards)
What is the signalling function to producers?
Consumers indicate to producers what they desire through the price they are willing and able to pay, which allows producers to know what to produce.
Eg. if prices rise due to higher demand, this signals to producers to expand production to achive greater profitability
What is consumer sovereignty in the free market?
Consumer sovereignty refers to a situation where consumer’s desries and wants control the producer’s output. Each consumer expresses their desires through their dollar vote. A higher dollar vote means higher demand for a good or service. Producers compete for higher dollar votes by diverting more of their resources to produce the good or service that pays more. Consumer sovereignty determines what good is produced in the market.
Define ceteris paribus.
The ceteis paribus assumption states that other than the variable being studied, every other variable that could affect the outcome remains constant
What is a market?
A market is the interaction between buyers and sellers where goods are exchanged at an agreed market price.
State the assumptions of the free market.
- Individuals are rational (ie economic agents make decisions based on their self-interest and apply the marginalist principle to achieve their objectives)
- There is a large number of consumers and producers in the market and no producer or consumer have power to influence the market outcomes.
- Perfect factor mobility and perfect information
Consumers want to maximise their satisfaction (utility) and producers want to maximise their profits
Define demand.
The demand of a good refers to the quantity of a good that consumers are willing and able to purchase at every given price over a given period of time, ceteris paribus.
What does the Law of Demand state?
The Law of Demand states that at a given time, the quantity demanded of a good is inversely related to its price.
What are the two determinants of demand and what are they represented by on a demand diagram?
Price determinant: When the price of the good itself changes, quantity demanded changes in the opposite direction. Represented by a movement along the same demand curve.
Non-price determinant: When demand changes for reasons not due to a change in price of the good itself. Represeted by a shift of the entire demand curve.
State the non-price determinants of demand.
E - expectations of consumers
G - Government policies
Y - Income of consumers
P- Population changes
P - Price changes of related goods
T - Tastes and peferences of consumers
Define supply.
The supply of a good refers to the quantity of the good that producers are willing and able to produce at every given price over a given period of time, ceteris paribus.
What does the Law of Supply state?
The Law of Supply states that the higher the price of a good, the greater the quantity supplied of the good, ceteris paribus. Hence quantity supplied is directly related to the price of a good.
What are the two determinants of supply and what are they represented by on a supply diagram?
Price determinant: When the price of the good itself changes, quantity supplied changes in the same direction. Represented by a movement along the same supply curve.
Non-price determinant: When supply changes for reasons not due to a change in price of the good itself. Represeted by a shift of the entire supply curve.
State the non-price determinants of supply.
W - Weather and seasons
E - Expectations of future prices
T - Technology
P - Price changes of related goods
I - Input prices/Cost of production
G - Government policies
Define market equilibrium.
Market equilibrium occurs at the intersection of the demand and supply curve, whereby quantity demanded is exactly equal to the quantity supplied at the equilibrium price. At this equilibrium, there is no tendency for the price and quantity to change.
Define a shortage and describe the price adjustment process during a shortage.
A shortage is when the price is below the equilibrium, hence quantity demanded is greater than the quantity supplied.
PAP: This shortage exerts an upward pressure on price as consumers compete for the limited good. This higher price signals and incentivises the profit-maximising producers to increase quantity supplied along the supply curve since it is more profitable to produce the good. With price increase, consumers are less willing and able to consume hence quantity demanded is reduced and price will continue rise until the shortage is eliminated and market equilibrium is achieved again.
Define a surplus and describe the price adjustment process during a shortage.
A surplus is when the price is above the equilibrium price, hence quantity supplied is greater than quantity demanded.
This surplus exerts a downward pressure on price as poducers lower prices to clear their inventories. The lower prices deincentivices the profit-maximizing producers, hence they will lower quantity supplied along the supply curve as it is less profitable to produce. With the drop in price, consumers are more willing and able to consume, hence this signals and incentivises consumers to increase quantity demanded along the demand curve. Price will continue to fall until the surplus is eliminated and market equilibrium is reached again.
Describe how income of consumers affect demand.
Changes in consumer’s income is usually caused by changes in national income of a country.
Normal goods: Goods whose demand is directly related to consumer’s incomes (ie when income increase, consumer’s demand for normal goods also increases) When there is an increase in income, there will be an increase in disposable income hence purchasing power increases. Consumers can purchase more goods at each price and hence an increase in demand, hence a rightward shift of demand curve.
Inferior goods: Goods whose demand is inversely related to consumer’s income. (Same as normal but) Consumers will now switch to consuming alternativr goods that they can better afford, hence demand for inferior goods decrease.
Describe how tastes and peferences of consumers affect demand.
The more desirable consumers find a good, their willingness to purchase the goo dincreases, hence the demand for that particular good will increase. Tastes and peferences can be influenced by the effects of advertising
Describe how the expectations of consumers affect demand.
Expectation in changes in price: When consumers expect the price of a good to rise in the future, they may buy more of the good today, causing the demand to rise. Conversely, if the price of a good is expected to fall, consumers will postpone their purchase, reducing demand.
Expectation in changes in income: When income is expected to increase in the future, consumers will have a tendency to be more generous in their current spending due to a perception of an increase in future purchasing power. Since they perceive their future increase in income will compensate their current spending, they spend more on big ticket items now, and hence an increase in demand.
Define substitute.
Substitudes ae alternatives of each other that satisfies similar consumer wants/needs.
Define complements.
Complements are goods and services that enhance consumers’ satisafaction when consumed together
Describe how a change in price of related goods affect demand.
Change in price of substitutes: If two goods are substitutes of each other, a fall in price of one good would lead to a fall in demand for the other good. Likewise, a rise in the price of one good would lead to a rise in demand for the other good.
Change in price of complements: If two goods are complements, a fall in the price of one good will lead to a rise in demand for the other good. Likewise, a rise in the price of one good will lead to the fall in demand for the other good.
Change in demand of final goods in markets for factor of production: The demand for factors of production is called derived demand, which is distinct from final demand. Derived demand for factors of production depends on the demand for the final good that uses it.
Describe how population size and structure affect demand.
Changes in population size: The market demand is a summation of all individual’s demand for a good. An increase in population size will lead to an increase in a certain goods such as basic necessities. Represented by a rightward shift of the demand good.
Changes in populaion structure: If population structure were to change, such as the rise in proportion of elderly, there will be an incease in demand for goods consumed by the elderly.
Describe how input prices/cost of production affect supply.
With higher factor input prices, the unit cost of production of the good increases, leading to a decrease in profit per unit of outut. Since producers are proft maximising, they are less willing and able to produce goods at every given price level and hence reducing the supply of the good, represented by a leftward shift in the supply curve.
