SUPPLY AND DEMAND: PART TWO

"Long before Einstein, economists had been aware that Earthly matter has four dimensions: Length, breadth, thickness, and price."

Anonymous

Concepts of : Increase and decrease in demand |Increase and decrease in supply |Inferior goods |Normal goods |Joint products |Shift in demand and supply | Substitute products |Substitutes |Complements|

Why do we hold price constant when we talk about increasing or decreasing demand?

• We hold the price constant to avoid confusing an event that causes a shift in demand while holding price constant with the events resulting from price changes.

Is it the same when people are willing to (1) buy more at each price and (2) pay a higher price for each quantity?

• Yes. Both show an increase in demand.

If consumers buy fewer burner covers for their stoves when their income goes up, are burner covers a normal good, or an inferior good?

• An inferior good.

When the price of a good’s complement goes up, what happens to the demand for the good?

• It shifts to the left and down.

Is it the same thing when suppliers are willing to (1) supply more at each price and (2) charge a lower supply price at each quantity?

• Yes. Both show an increase in supply.

What is the sequence of events for describing how an event affects price and quantity?

• Equilibrium, event and shift, shortage or surplus at old equilibrium price, movement to new equilibrium price, new equilibrium.

Does an increase in both price and output violate the law of demand?

• No. This event occurs when demand shifts to the right.

If the cost of production goes up, does the supply curve shift to the left, or to the right?

• To the left.

What is the only factor that changes the quantity demanded (and supplied) but not demand (and supply)?

• Price.

If world demand for wheat goes up and at the same time farmers find a cheaper way to grow wheat, what will happen to wheat prices and output?

• Wheat prices: effect is uncertain. Wheat output: up.

In 1970, electronic calculators cost over $100. Today, calculator with the same capacity cost under $10. Yet more are sold to day than in 1970. Does this violate the law supply?

• No. The event describes the effects of an outward shift in the supply curve, not a movement along the supply curve.

There is currently a trend toward “natural clothing.” This trend has increased the demand for clothing made out of cotton. How will this trend affect the price of cotton sheets?

• Because of the increase in demand for cotton, the price of cotton will rise. This higher cost will reduce the supply of sheets, raising the price.

In Yorkville, rent controls have caused a shortage of apartments. If rent controls (which impose a price floor on rents) were removed, what would happen to the quantity of apartments demanded? To the quantity supplied. To the number of apartments rented?

• As rents rise, the quantity demanded will go down while the quantity supplied will go up. This will remove the shortage. The number of apartments rented will go up.

The third and fourth sentences of the following statement are wrong. Why? “Consumer demand for cars has increased because of higher consumer income. As a consequence, the price of cars has risen. We know that when the price of cars goes up, the demand will go down. So fewer cars will be bought when consumer income goes up.”

• What we “know” is that when the price goes up, the quantity demanded goes down, but “demand” and the demand curve remain unchanged. The price goes up because if it did not, there would be a shortage of cars. As the price goes up, the quantity demanded on the newnet the quantity demanded will go up because of the shift in demand. Also, the higher price causes the quantity supplied on the old supply curve to go up. This gets rid of the shortage.

Copyright 2007 by Sujanto Rusli
http://economicslessons.blogspot.com
http://become-debt-free.blogspot.com
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SUPPLY AND DEMAND: PART ONE

“If demand is the mother of supply, why are there so many undemanded goods and services supplied in the economy?”

Mid-term exam question in Econ 101 class.

The Main Concepts of : Law of Demand | Law of Supply | Market Clearing Price | Market Equilibrium | Non-Price Rationing | Price Floors and Ceilings | Quantity Demanded | Quantity Supplied | Relative Price | Shortage | Surplus |

Is the quantity demanded different from the quantity bought?

• Yes. For example, at a price of $1,000 per home, the quantity demanded would likely be very high, but the amount people would sell at this price would be zero. So the quantity demanded will not equal the quantity actually bought, except in equilibrium.

Is the quantity supplied different from the quantity sold?

• Yes.

What is the difference between scarcity and shortage?

• Scarcity is when there are not enough units of a good to satisfy all of everyone’s wants when the price of the good is zero. A shortage is when there are not enough units sold at a given price to satisfy what people want to buy at that price.

Can there be a surplus of a scarce good?

• Yes; just impose a price floor above the equilibrium price.

How can a merchant tell whether his or her price is too low? Too high?

• If the price is too low; there is excess demand for the merchant’s goods. If it is too high, there is excess supply.

Does demand change when the price changes?

• No. The quantity demanded changes when the price changes.

When there is a shortage, how will the price change? What will happen to the quantity demanded and supplied?

• The price will rise; the quantity demanded will decrease while the quantity supplied will increase.

Why does an individual usually buy more of a good when its price falls?

• Income effect and substitution effect

Is a market in equilibrium when the amount bought equals the amount sold?

• No. The market is in equilibrium only when the quantity demanded equals the quantity supplied.

If the price of TVs stays at $200 while inflation continues, what will happen to the demand for TVs according to the law of demand?

• The relative price of TVs will fall, so the quantity demanded will increase.

Is the following statement correct? “Home prices are so high there is a shortage of homes. Not everyone who wants a home will be able to buy one.”

• The statement is incorrect. At the equilibrium price, there will be no shortages, since all buyers who want homes at prevailing prices will get them. If there were a shortage of homes, the price would rise until the housing market reached equilibrium.

Suppose a rent control law forces rents below the market level of rents. How might owners of apartment buildings offset the effects of rent control laws on their profits?

• Rent controls create a shortage of apartments, so owners can cut back on maintenance and service without losing renters. Apartment owners also may seek ways to charge renters for “extra” services, even if these ways are illegal. For example, some apartment owners have allegedly used these methods to reduce the adverse impact of rent controls: (1) “key money” for the key to the apartment. (2) kickbacks from rental brokers who get paid to find apartment for their clients, and (3) lower pay to the apartment’s superintendent, who then collects “tips” from renters.

Over a two-year period, the price of TVs went up 5% and the price of all other goods went up 12%. During the same period, more TVs were sold. Does this support or contradict the law of demand?

• The relative price of TVs went down over the two-year period (by 7%) and more TVs were demanded. So this supports the law of demand.

If each person demands one movie a month when one movie ticket costs $6, two movies a month when each costs $4, and three when each costs $2, what will the total demand be for 100 people for each price?

• The market demand is the sum of the individual’s demand at each price. At $6 per movie ticket, 100 tickets will be sold. At $4, 200 tickets, and a $2, 300 tickets.

How would you expect a minimum wage (that is above market clearing wage) to affect the working conditions and the on-the-job training supplied by employers?

• A minimum wage prevents employers from offering lower wages in exchange for training and good working conditions. As a consequence, employers faced with a minimum wage that is above what they’d otherwise pay will cut back on training (by hiring only experienced workers) and be less concerned with working conditions. One study found that minimum wages actually caused many workers to lose more, in training and working conditions, than they gained from higher wages.

Use the law of demand and the concept of relative price to explain why a higher percentage of the oranges sold in New York City are of better quality than oranges sold in Florida?

• The cost of transporting and selling oranges in NYC does not depend on their quality. Therefore, the relative price of high-quality oranges is less in NYC, so the law of demand predicts relatively more high-quality oranges will be demanded in NYC. For example, suppose a carton of low-quality oranges costs $10 in Florida, while high-quality oranges cost $15. If it costs $5 to ship a carton, the NYC, price will be $15 and $20 respectively. The relative price of high-quality oranges is 1.5 in Florida (1.5 = $15/$10) but only 1.33 in NYC (1.33= $20/$15).

Suppose that employers dislike hiring dark-haired workers and suffer a loss in their personal satisfaction equivalent to $1 an hour for each hour they employ a dark-haired worker. How could a dark-haired worker then get a job with an employer? In this case, what would be the effect of a minimum wage law that pushed dark-haired workers wages up by $1?

• Dark-haired workers can get a job with employers if they work for $1 less per hour than do other workers. This will compensate the employers for their dislike of dark-haired workers. A minimum wage that prevents dark-haired workers from accepting lower wages in order to get work will reduce their employment.

When Peter earned $10, he bought four hamburgers at $2 each and two sodas at $1. In the following month, he earned $20, but the price of hamburgers had risen to $3 and the price of sodas had risen to $4. So if Peter wanted to, he could still buy four hamburgers and two sodas. Will he?

• The relative price of sodas has gone up from one-half ($1/$2) to four-thirds ($4/$3) of a hamburger. The substitution effect predicts that Peter will substitute “away” from sodas “toward” hamburgers.

Copyright 2007 by Sujanto Rusli
http://economicslessons.blogspot.com
http://become-debt-free.blogspot.com
http://humorandwit.blogspot.com

THE BASIC OF ECONOMICS

"Against logic there is no armor like ignorance"

Ancient Saying.

Main Concepts : Economic of Poverty | Economic of Scarcity | Economic of Opportunity Cost | Economic Production Possibility Frontier | Economic Marginal Analysis | Economic Marginal Analysis | Economic Marginal Cost | Economic Division of Labor | Economic Efficiency | Economic of Growth | Economic of Investment | Economic Net Benefit | Economic of Specialization | Economic of Trade off.

How do scarcity and poverty differ?

• Poverty is having few goods. Scarcity is having more wants than goods with which to satisfy them, even if one has many goods.

Why can’t Opportunity Costs exist without Scarcity?

• Without Scarcity, there are no alternatives that have to be given up, and thus there are no Opportunity Costs.

Does an economy that is inside its Production Possibilities Curve face any trade-offs?

• No. It can have more of all goods.

How can a good be costly yet not scarce?

• If a costly good is not desirable, it will not be scarce.

What factors cause the Production Possibilities Curve to be bowed out?

• Diminishing returns and the fact that some inputs are more suitable than others for producing certain goods cause the bowing out of the Production Possibilities Curve. When the curve is bowed out, as more of any good is produced its Opportunity Cost goes up.

What will cause an economy Production Possibility Curve to shift out and to the right?

• More investments. Innovation. Increased division of labor. Additional inputs.

How are trade and the division of labor related?

• The division of labor means that workers specialize. They must then trade what they produce to get the goods they want to consume.

If the marginal cost of an action exceeds its marginal benefit, why will net benefits fall?

• When marginal costs exceeds its marginal benefits, more is being added to total costs than total benefits, so net benefits must fall.

Why do people value each unit of a good by its marginal value?

• People value a unit of a good by what would be lost if they didn’t have the unit. By interchanging units of the good, a person would have to lose only the least-valued use a unit of the good is being put to, i.e., its marginal value.

Why is the Opportunity Cost of an option equal to the value of the best of all the alternatives that had to be forgone?

• The Opportunity Cost of a decision is the value of what the person would have done otherwise. If the person is rational, they would otherwise have chosen the most valuable of the alternative options.

Studies have shown that females put a lot of time into raising children. How would increase in female wages that has occurred over the last three decades affect the cost of raising children?

• One of the main costs of raising children is the opportunity cost of female time. Because female wages have been rising, the effect has been to significantly increase the cost of raising children. Many economists believe that this may partly explain the drop in the number of children per household that has occurred in recent times.

You have ten workers who are equally skilled and who can do each other worker’s job with the same efficiency. The first workers does a task worth $100, the second, $90, the third, $80, and so on until the last, whose task is worth $10. Worker number one comes to you, demands a raise, and threatens to quit if the raise is not forthcoming. How much at most should you be willing to pay worker number one?

• If worker number one quit, the other workers could be reassigned tasks and you would be worse off by only $10. So worker one should be paid no more than $10.

Use the principle of opportunity cost to explain why firms might spend more time training workers when there is a recession in their industries (assuming the firms expect to retain the workers and the recession to eventually end).

• The opportunity cost of training a worker is the value of what the worker would have been doing otherwise. Most likely, this would be producing goods for the firm to sell. But during a recession, this forgone cost is likely to be lower (since the firm has to sell its output at a lower cost or perhaps can’t sell it at all0. So this is the cheapest time to train workers.

What is wrong (from an economic point of few) with the following argument? “Marketing is vitally important. After all, without marketing, we wouldn’t sell anything and our firm would be bankrupt. Therefore, our firm should spend more on marketing.”

• This argument tries to measure the value of an additional expenditure on marketing not by its marginal contribution, but rather by the total value of all marketing. The correct way to evaluate the issue is to ask if the additional money spent on marketing is matched or exceeded by its additional or marginal benefit.

Currently, our military is voluntary, the armed forces sets its wages and benefits so it can attract an adequate and presumably skilled body of soldiers. In the past, our nation has used the draft, forcing people into military service at low pay. If we were to return to a draft, how would the opportunity cost of maintaining out military be affected?

• The cost of maintaining our military forces is the opportunity cost of what the people in the military would have been doing otherwise. With a pay system, only those people whose opportunity cost falls below what the armed forces pay will join. But with a draft, persons with higher opportunity costs will likely be forced into service. Thus, the total opportunity cost of a draft will be higher.

An economy is producing two goods, A and B. Then there is technological progress, but in Good A only. Can the economy then consume more of both goods?

• Yes. To produce the “old” amounts of Goods A and B takes less inputs; the leftover inputs can then be used to produce more A and B.

Afdol Manufacturing has spent $100,000 on safety equipment. If it spends an additional $20,000, its losses from accidents will fall from $160,000 to $130,000. Should it spend the additional $20,000?

• The control variable is safety. More safety has a marginal costs of $20,000. Its marginal benefit is the reduction in accident losses: $30,000 ($160,000 - $130,000). So the firm should spend the additional $20,000.

Copyright 2007 by Sujanto Rusli
http://economicslessons.blogspot.com
http://become-debt-free.blogspot.com
http://humorandwit.blogspot.com