Demand and Supply

INTRODUCTION TO ECONOMICSWITH LAND REFORM AND

TAXATIONDR. ABRAHAM C. CAMBA JR.

Department of Economics, San Beda College, Mendiola, Manila andPolytechnic University of the Philippines, Sta. Mesa, Manila

DR. AILEEN L. CAMBAGraduate School and Department of Economics

Polytechnic University of the Philippines, Sta. Mesa, Manila

Lecture 2

DEMNAD AND SUPPLY

CONTENTS

2.1 Markets 2.2 Demand2.3 Supply

HOMEWORK

REFERENCES

2.1 Markets

We usually think of a market as a place where some sort of exchange occurs. A market is not really a place at all but the process of buyers and sellers exchanging goods and services. Examples are securities markets, auction markets, foreign exchange markets, real estate markets, labor markets, and so forth.

Every market is different. That is, the condition under which the exchange between buyers and sellers takes place can vary. These differences make it difficult to precisely define a market1. The important point is not what a market looks like, but what it does –it facilitates trade.

Product and Resource Markets

The circular flow model of the economy helps us organize our thinking about markets. It shows how we can divide markets into two major categories: product markets and resource markets.

Exhibit 1. The Circular Flow Model

Figure 1 shows the product markets where goods and services such as soft drinks, softwares, gasoline, DVDs, educational services, medical services, and more are bought and sold. The outer arrows represent the flow of goods and services from business firms (the sellers) to households (the buyers). The inner arrows show the associated flow of funds, where household payments for goods and services (expenditures) become the receipts of businesses (revenue). The lower half of the diagram depicts another type of market: resource markets, where labor, land, capital, and entrepreneurship are bought and sold. In these markets, as shown by the outer 1 In economics, markets can be defined broadly or narrowly, depending on the purpose.

Product Markets Households Buy Firms Sell

Resource Markets Households Sell Firms Buy

Business Firms Sell Goods and

Services Buy Inputs

Households Buy Goods and

Services Sell Inputs

Expenditures

Goods and Services

Goods and Services

Revenue

Resource Payments

ResourcesResources

Income

arrows, households (the ultimate owners of resources) act as sellers. Business firms, which use resources to make goods and services, are the buyers. The inner arrows in the lower half of the diagram show us that when businesses pay for the resources they use (resource payments), the funds flow to households (income).

Let’s take a simple example to see how the circular flow model works. Suppose a teacher’s supply of labor generates personal income in the form of wages (the resource market), which she can use to buy automobiles, vacations, food, and other goods (the product market). Suppose she buys an automobile (product market); the automobile dealer now has revenue to pay for his inputs (resources market) – wages to workers; purchase of new cars to replenish his inventory, rent for his building, and so on. So we see that in the simple circular flow model, income flows from firms to households (resource markets), and spending flows from households to firms (product markets).

The simple circular flow model shows how households and firms interact in product markets and resource markets and how the two markets are interrelated. There is, of course, much more to the economy than this simple model captures. For example, we’ve left out the government, which buys many goods and services, and also produces some for the general public. And we’ve left out some markets entirely, such as markets where borrowing and lending takes place, or markets where foreign currencies are traded.

But for many problems, the simple circular flow model can help us understand and identify the participants and the type of market we are discussing.

Buyers and Sellers

The roles of buyers and sellers in markets are important. Buyers, as a group, determine the demand side of the market. Buyers include the consumers who purchase the goods and services and the firms that buy inputs – labor, capital, and raw materials. Sellers, as a group, determine the supply side of the market. Sellers include the firms that produce and sell goods and services and the resource owners who sell their inputs to firms - workers who “sell” their labor and resource owners who sell raw materials and capital. The interaction of buyers and sellers determines market prices and output – through the forces of supply and demand.

2.2 Demand

The quantity demanded of a good or services is the number of units that all buyers in a market would choose to buy over a given time period, given the constraints that they face.

Since this definition plays a key role in any supply and demand analysis, it’s worth taking a closer look at it.

Implies a choice

Quantity demanded doesn’t tell us the amount of a good that households feel they “need” or “desire” in order to be happy. Instead, it tells us how much households would choose to buy when they take into account the opportunity cost of their decisions. The opportunity cost arises from the constraints households face, such as having to pay a given price for the good, limits on spendable funds, and so forth.

Is hypothetical

Will households actually be able to purchase the amount they want to purchase? There are special situations in which households are frustrated in buying all that they would like to buy. Quantity demanded makes no assumptions about the availability of the good. Instead, it’s the answer to a hypothetical question: How much would households buy, given the constraints that they face, if the units they wanted to buy were available.

Depends on price

The price of the good is just one variable among many that influences quantity demanded.

Note that willingness alone is not effective in the market. You may be willing to buy a cellular phone, but if that willingness is not backed by the necessary pesos (or dollars), it will not be effective and, therefore, will not be reflected in the market. Also, to be meaningful, the quantities demanded at each price must relate to a specific period- a day, a week, a month. Saying “A consumer will buy 10 kilograms of rice at P35 per kilogram” is meaningless. Saying “A consumer will buy 10 kilograms of rice per week at P35 per kilogram” is meaningful. Unless a specific time period is stated, we do not know whether the demand for a product is large or small.

THE LAW OF DEMAND

According to the law of demand, the quantity of s good or service demanded varies inversely (negatively) with its price, ceteris paribus. More directly, the law of demand says that, other things being equal, when the price (P) of a good or service falls, the quantity demanded (QD) increases, and conversely, if the price of a good or service rises, the quantity demanded decreases.

P QD and P QD

Three explanations why price and quantity demanded are inversely related:

1. Consistent with common sense. People ordinarily do buy more of a product at a low price than at a high price. Simply, higher price deter consumers from buying and the lower the price obstacle, the more the will buy.

2. Consumption is subject to diminishing marginal utility. In any specific time period, each buyer of a product will derive less satisfaction (or benefit, or utility) from each successive unit of the product consumed. Because successive units of a particular product yield less and less marginal utility, consumers will buy additional units only if the price of those units is progressively reduced.

3. Income and substitution effects. The income effect indicates that a lower price increases the purchasing power of a buyer’s money income, enabling the buyer to purchase more of the product than she or he could buy before. A higher price has the opposite effect. The substitution effect suggests that at a lower price, buyers have the incentive to substitute what is now a less expensive product for similar products that are now relatively more expensive. The product whose price has fallen is now a better deal relative to the other products.

For example, a decline in the price of Nokia cellular phone will increase the purchasing power of consumer incomes, enabling people to buy more Nokia cellular phone (the income effect). At a lower price, Nokia is relatively more attractive and consumers tend to substitute it for Sanyo, Sony Ericsson, Samsung, and Motorola (the substitution effect). The income and substitution effects combine to make consumers able and willing to buy more of a product at a low price that at a high price.

INDIVIDUAL DEMAND

An Individual Demand Schedule

The individual demand schedule shows the relationship between the price of the good and the quantity demanded. For example, suppose Aryannah enjoys eating ice candy. How much ice candy would Aryannah be willing and able to buy at various prices per month. At a price of 3 per ice candy, Aryannah buys 20 pieces of ice candy over a month. If the price is higher, at P4 per ice candy, she might buy 25 pieces of ice candy during the month. Aryannah’s demand for ice candy for the year is summarized in the demand schedule in Exhibit 2.

Exhibit 2Aryannah's DemandSchedule for Ice Candy

Price of Ice Candy

Quantity of Ice Candy Demanded

(per piece) (piece per month)P5 54 103 152 201 25

Aryannah might not be consciously aware of the amounts that she would purchase at prices other than the prevailing one, but that does not alter the fact that she has a schedule in the sense that she would have bought various other amounts had other prices prevailed. It must be emphasized that the schedule is a list of alternative possibilities. At any one time, only one of the prices will prevail, and thus a certain quantity will be purchased.

AN INDIVIDUAL DEMAND CURVE

As we plot the different prices and corresponding quantities demanded in Aryannah’s demand schedule in Exhibit 2 and then connecting them, we can create the individual demand curve for Aryannah shown in Exhibit 3.

Exhibit 3. Aryannah’s Demand Curve for Ice Candy

0 5 10 15 20 25 300

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Aryannah's Demand Curve

From the curve, we can see that when the price is higher, the quantity is lower, and when the price is lower, the quantity demanded is higher. The demand curve shows how the quantity demanded of the good changes as its price varies.

A MARKET DEMAND CURVE

Economists usually speak of the demand curve in terms of large groups of people – a whole nation, a community, or a trading area. The horizontal summing of the demand curves of many individuals is called the market demand curve.

Suppose the consumer group is composed of Annikah, Gregg, and the rest of their town, Baliuag, Bulacan, and that the product is still ice candy. The effect of price on the quantity of ice candy demanded by Annikah, Gregg and the rest of Baluiag, Bulacan is given in the demand schedule and demand curves shown in Exhibit 4. At Ph4.00 per piece, Annikah would be willing and able to buy 20 pieces of ice candy per month, Gregg would be willing and able to buy 10 pieces, and the rest of Baliuag, Bulacan would be willing and able to buy 2,970 pieces. At Ph3.00 per piece, Annikah would be willing and able to buy 25 pieces of ice candy per month, Gregg would be willing and able to buy 15 pieces, and the rest of Baliuag, Bulacan would be willing and able to buy 4,960 pieces. The market demand curve is simply the (horizontal) sum of the quantities Annikah, Gregg, and the rest of Baliuag, Bulacan demand at each price. That is, at Ph4.00, the quantity demanded in the market would be 3,000 pieces of ice candy (20 + 10 + 2,970 = 3,000), and at Ph3.00, the quantity demanded in the market would be 5,000 pieces of ice candy (25 + 15 + 4,960 = 5,000).

Exhibit 5 offers a more complete set of prices and quantities from the market demand for ice candy during the month. Remember, the market demand curve shows the amounts that all the buyers in the market would be willing and able to buy at various prices. For example, when the price of ice candy is Ph2.00 a piece, consumers in the market collectively would be willing and able to buy 8,000 pieces per month. At Ph1.00 per piece, the amount collectively demanded would be 12,000 pieces per month.

CHANGE IN QUANTITY DEMANDED

Understanding the relationship between price and quantity demanded is so important that economists make a clear distinction between it and the various other factors that can influence consumer behavior. A change in a good’s own price is said to lead to a change in quantity demanded. That is, it “moves you along” a given demand curve. The demand curve is drawn under the assumption that all other things are held constant, except the price of the good.

Exhibit 4. Creating a Market Demand Curve for Ice Candy

Annikah + Gregg + Rest of Baliuag = Market Demand

Exhibit 5. A Market Demand Curve

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Market De-mand Curve

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SHIFTS IN DEMAND

Economists know that price is not the only thing that affects the quantity of a good that people buy. The other factors that influence the demand curve are called determinants of demand, and a change in these other factors shifts the entire demand curve. These determinants of demand are called demand shifters and they lead to changes in demand.

In Exhibit 6, the movement from A to B is called an increase in quantity demanded; the movement from B to A is called a decreased in quantity demanded. Economists use the phrase “increase or decrease in quantity demanded” to describe movements along a given demand curve.

Exhibit 6. Changes in Demand versus Changes in Quantity Demanded

However, the change from A to C is called an increase in demand, and the change from C to A is called a decrease in demand. The phrase “increase or decrease in demand” is reserved for a shift in the whole curve.

SOME POSSIBLE DEMAND SHIFTERS

1. The Prices of Related Goods

Sometimes, consumers are also influenced by the prices of related goods and services – substitutes and complements.

Substitutes. Is it possible that you might decide to buy Sarsi Cola instead of RC Cola? Economists argue that most people would be, and empirical tests have confirmed that consumers are responsive to both the price of the good in question and the prices of related goods. Sarsi Cola and RC Cola are said to be substitutes. Two goods are

Quantity of CDs

Price

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CD

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CP1

P2

Q1 Q20

Q3

substitutes if an increase (a decrease) in the price of one good causes the demand curve for another good to shift to the right (left) – a direct (or positive) relationship.

Exhibit 7. Substitute Goods

Substitutes are generally goods for which one could be used in place of the other, such as butter and margarine, movie tickets and video rentals, jackets and sweaters, and Nikes and Reeboks.

Complements. Two goods are complements if an increase (a decrease) in the price of one good shifts the demand curve for another good to the left (right). Complements are goods that “go together,” often consumed and used simultaneously, such as hotdogs and buns, DVDs and DVD players, printers and ink cartridges. For example, if the price of motorcycles rises, it causes the demand for motorcycles helmets to fall (shift to the left), because the two goods are complements. A decrease in the price of stereo equipment leads to an increase in the demand (a rightward shift) for compact discs, because stereos and CDs are complements.

Exhibit 8. Complementary Goods

Quantity of Sarsi Cola

Price

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Cola

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2. Income

Economists have observed that generally the consumption of goods and services is positively related to the income available to consumers. Empirical studies support the notion that as individuals receives more income, they tend to increase their purchases of most goods and services. Other things held equal, rising income usually leads to an increase in the demand for goods (a rightward shift of the demand curve), and decreasing income usually leads to a decrease in the demand for goods (a leftward shift of the demand curve).

Normal and Inferior Goods. If demand for a good increases when incomes rise and decreases when incomes fall, the good is called a normal good. Examples of normal goods are CDs, clothes, pizzas and trips to the movies. Consumers will typically buy more of these goods as their incomes rise.

However, if demand for a good decreases when incomes rise or if demand increases when incomes fall, the good is called an inferior good. As incomes rise, buyers shift to preferred substitutes and decrease their demand for the inferior goods.2

Exhibit 9. Normal Goods

2 The term inferior in this sense does not refer to the quality of the good in question but shows that demand decreases when income increases and demand increases when income decreases.

Quantity of Computers

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If people’s incomes rise and they increase their demand for movie tickets, we say that movie tickets are a normal good. But if people’s incomes fall and they increase their demand for jeepney rides, we say jeepney rides are an inferior good.

Exhibit 10. Inferior Goods

Whether goods are normal or inferior, the point here is that income influences demand – usually positively, but sometimes negatively.

3. Number of Buyers

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The demand for a good or service will vary with the size of the potential consumer population. The demand for rice, for example, rises as population increases, because the added population will consume more rice. Marketing experts, who closely follow the patterns of consumer behavior regarding a particular good or service, are usually vitally concerned with the demographics of the product – the vital statistics of the potential consumer population, including size, race, income, and age characteristics.

Exhibit 11. Increase in the Number of Buyers

4. Tastes

The demand for a good or service may increase or decrease suddenly with changes in fashions or fads. Changes in taste may be triggered by advertising or promotion, a news story, behavior of some popular public figure, and so on.

Exhibit 12. Taste Change in Favor of the Good

Changes in preferences naturally lead to changes in demand. Much of the predictive power of economic theory, however, stems from the assumption that tastes are

Quantity (Low-Quality Furniture)

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relatively stable, at least over a substantial period of time. Tastes do change, though. A person may grow tired of one type of recreation or food and try another type. Changes in occupation, number of dependents, state of health, and age also tend to alter preferences. Changes in customs and traditions also affect preferences, and the development of new products draws consumer preferences away from other goods. Compact discs replaced record albums, just as DVD players replaced VCRs.

5. Expectations

Sometimes the demand for a good or service in a given period will dramatically increase or decrease because consumers expect the good to change in price or availability at some future date. The expectation of future higher prices for Payless Noodles caused an increase in current demand. That is, the change in buyer’s expectations caused the current demand curve for noodles to shift to the right. Other examples, such as waiting to buy your own laptop because reductions may be even greater in the future, are also common. Or, if you expect to earn additional income next month, you may be more willing to dip into your current savings to buy something this month.

Exhibit 13. Future Price Increase Expected

2.3 Supply

Quantity supplied is the number of units of a good that all sellers in the market would choose to sell over some time period, given the constraints that they face. Let’s briefly go over the notion of quantity supplied to clarify what it means.

Implies choice

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It is assumed that business firms have a simple goal – to earn the highest possible profit. But they also face constraints: the specific price they can charge for the good, the cost of any inputs used, and so on. Quantity supplied does not tell us the amount of, say, Kraft Cheez Whiz Pimiento that groceries would like to sell if they could change a hundred pesos for each bottle, and if they could produce it at zero cost. Instead, it’s the quantity that firms choose to sell – the quantity that give them the highest profit given the constraints they face.

Is hypothetical

Will firms actually be able to sell the amount they want to sell at the going price? The definition of quantity supplied makes no assumption about firm’s ability to sell the good. Quantity supplied answers the hypothetical question: How much would firms’ managers sell, given the constraints they face, if they were able to sell all that they wanted.

Depends on price

The price of the good is just one variable among many that influences quantity supplied.

THE LAW OF SUPPLY

Economists expect that, other things being equal, the quantity supplied will vary directly with the price of the good, a relationship called the law of supply. According to the law of supply, the higher the price of the good (P), the greater the quantity supplied (QS), and the lower the price of the good, the smaller the quantity supplied.

P QS and P QS

The relationship described by the law of supply is a direct, or positive, relationship, because the variables move in the same direction.

WHY POSITIVE RELATIONSHIP BETWEEN PRICE (P) AND QUANTITY SUPPLIED (QS)?

Greater Profitability

Firms supplying goods and services want to increase their profits, and the higher the price per unit, the greater the profitability generated by supplying more of that good. For example, if you were a rice retailer, wouldn’t you much rather be paid Ph35 a kilogram than Ph30 a kilogram, ceteris paribus?

Law of Increasing Opportunity Cost

Producing additional units of a good will require increased opportunity costs. That is, when we produce something, we use the most efficient resources first (those with the lowest opportunity cost) and then draw on less efficient resources (those with a higher opportunity cost) as more of the good is produced. So if costs are rising for producers as they produce more units, they must receive a higher price to compensate them for their higher costs. Perhaps palay farmers have to use less fertile soil for their palay crop as they produce more and more palay. Simply, increasing production costs mean that suppliers will require higher prices to induce them to increase their output.

AN INDIVIDUAL SUPPLY CURVE

The law of supply can be illustrated using a table or graph. Gregg’s supply schedule for purified drinking water is shown in Exhibit 14.

Exhibit 14. Gregg’s Individual Supply Curve for Purified Drinking Water

Supply Schedule Supply Curve

Price Quantity Supplied

(Peso per liter) (liters per month) 1.00 30 2.00 50 3.00 70 4.00 90 5.00 100

Note that the individual supply curve is upward sloping as you move from left to right. At higher prices, it will be more attractive to increase production. Business firms will produce more at higher prices than at lower prices.

THE MARKET SUPPLY CURVE

The market supply curve may be thought of as the horizontal summation of the supply curves for individual firms. Exhibit 15 shows a graphical representation of the amount of purified drinking water that suppliers are willing and able to supply at various prices.

Exhibit 15. A Market Supply Curve for Purified Drinking Water

Quantity Supplied

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Supplier AOther

SuppliersMarket Supply

5.00 100 9900 10000 4.00 90 8910 9000 3.00 70 6930 7000 2.00 50 4950 5000 1.00 30 2970 3000

A CHANGE IN QUANTITY SUPPLIED VERSUS A CHANGE IN SUPPLY

Changes in the price of a good lead to changes in the quantity supplied by suppliers, just as changes in the price of a good lead to changes in the quantity demanded by buyers. Similarly, a change in supply, whether an increase or decrease, can occur for reasons other than changes in the price of the product itself. In other words, a change in the price of the good in question is shown as a movement along a given supply curve, leading to a change in quantity supplied. A change in any other factor that can affect supplier behavior (input prices, the prices of related products, expectations, number of suppliers, technology, regulation, taxes and subsidies, and weather) results in a shift in the entire supply curve, leading to a change in supply.

Exhibit 16. Change in Supply vs. Change in Quantity Supplied

The price of cotton increases, so the quantity supplied changes (i.e., a movement along the supply curve). The good weather causes the supply curve for cotton to shift to the right, which is called a change in supply (not quantity supplied). A shift in the whole supply curve is not caused by a change in the price of the good.

As shown in Exhibit 16, the movement from A to B is called an increase in quantity supplied, and the movement from B to A is called a decreased in quantity supplied. However, the change from B to C is called an increase in supply, and the movement from C to B is called a decrease in supply.

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SHIFTS IN SUPPLY: SOME POSSIBLE DETERMINANTS

We will now look at some of the possible determinants of supply – factors that determine the position of the supply curve.

1. Input Prices

Suppliers are strongly influenced by the costs of inputs used in the production process, such as steel use for jeepneys or microchips used in computers. For example, labor, materials, energy, or other input costs increase the production costs, causing the supply curve to shift to the left at each and every price. If input prices fall, the costs of production decrease, causing the supply curve to shift to the right – more will be supplied at each and every price.

Exhibit 17. Input Prices (wages increase)

2. Prices of Substitutes in Production

The supply of a good increases if the price of one of its substitutes in production falls; and the supply of a good decreases if the price of one of its substitutes in production rises. Suppose you own your own farm, on which you plant rice and corn. Suddenly, the price of corn falls, and farmers reduce the quantity of corn supplied. What effect does the lower price of corn have on your rice production? It increases the supply of rice. You want to produce relatively less of the crop that has fallen in price (corn) and relatively more of the now more attractive other crop (rice). Producers tend to substitute the production of more profitable products for that of less profitable products. So the decrease in the price in the corn market has caused an increased in supply (a rightward shift) in the rice market.

Exhibit 18. Price decreases for a substitute in production

S2 S1Price

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3. Expectations

Another factor shifting supply is suppliers’ expectations. If producers expect a higher price in the future, they will supply less now than they otherwise would have, preferring to wait and sell when their goods will be more valuable. For example, if a rice retailer expected the future price of rice to be higher next month, he might decide to store some of his current supply of rice for next month when the price will be higher. Similarly, if retailers expect now that the price will be lower later, they will supply more now.

Exhibit 19. Producer expects now that the price will be lower later

4. Number of Suppliers

An increase in the number of suppliers leads to an increase in supply, denoted by a rightward shift in the supply curve. An exodus of suppliers has the opposite impact, a decrease in supply, which is indicated by a leftward shift in the supply curve.

Exhibit 20. Number of suppliers increases

0Quantity

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5. Technology

Decreases in costs often occur because of technological progress, and such advances can lower prices. Human creativity works to find new ways to produce goods and services using fewer or less costly inputs of labor, natural resources, or capital. In recent years, despite generally rising prices, the prices of computers, cellular phones, and DVD players have fall dramatically. Graphically, the increase in supply is indicated by a shift to the right in the supply curve.

Exhibit 21. Technological advance occurs

6. Regulation

Supply may also change because of changes in the legal and regulatory environment in which firms operate. For example, if new safety or clean air requirements increase labor and capital costs, the increased cost will result, other things being equal, in a decrease in supply, shifting the supply curve to the left. However, deregulation can shift the supply curve to the right.

Exhibit 22. Clean air requirement

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7. Taxes and Subsidies

Certain types of taxes also alter the costs of production borne by the supplier, causing the supply curve to shift to the left at each price. A subsidy, the opposite of a tax, can lower a firm’s costs and shift the supply curve to the right. For example, the Philippine government through the National Food Authority (NFA) provides farmers with subsidies to encourage the higher production of palay.

Exhibit 23. Taxes rises

Exhibit 24. Government subsidies

8. Weather

Weather can certainly affect the supply of certain commodities, particularly agricultural products and transportation services. A drought will cause the supply curves for many

0Quantity

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crops to shift to the left, while exceptionally good weather can shift a supply curve to the right.

Exhibit 25. Bad weather

HOMEWORK

Multiple Choice Questions

1. A market:a. Reflects upsloping demand and downsloping supply curvesb. Entails the exchange of goods, but not services.c. Is an institution that brings together buyers and sellers.d. Always requires face-to-face contact between buyer and seller.

2. The law of demand states that:a. Price and quantity demanded are inversely related.b. The larger the number of buyers in a market, the lower will be product price.c. Price and quantity demanded are directly related.d. Consumers will buy more of a product at high prices than at low prices.

3. Graphically, the market demand curve is:a. Steeper than any individual demand curve that is part of it.b. Greater than the sum of the individual demand curves.c. The horizontal sum of individual demand curves.d. The vertical sum of individual demand curves.

4. In presenting the idea of a demand curve economists presume that the most important variable in determining the quantity demanded is:a. The price of the product itself.b. Consumer income.c. The prices of related goods.d. Consumer tastes.

5. The income and substitution effects account for:a. The upward sloping supply curve.

S2 S1Price

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b. The downward sloping demand curve.c. Movements along a given supply curve.d. The “other things equal” assumption.

6. When the price of a product rises, consumers shift their purchases to other products whose prices are now relatively lower. This statement describes:a. An inferior good.b. The rationing function of prices.c. The substitution effect.d. The income effect.

7. In the past few years, the demand for donuts has greatly increased. This increase in demand might best be explained by:a. An increase in consumer income.b. An increase in the price of a substitute good.c. A change in consumer expectations.d. A change in buyer tastes.

8. An economist of Globe Telecommunications predicts that, other things equal, a rise in consumer incomes will increase the demand for cellular phones. This prediction is based on the assumption that:a. There are many products that are substitutes for cellular phones.b. There are many products that are complementary to cellular phones.c. There are few products that are substitutes for cellular phones.d. Cellular phones are normal goods.

9. If consumers are willing to pay a higher price than previously for each level of output, we can say that the following has occurred:a. A decrease in demand.b. An increase in demand.c. A decrease in supply.d. An increase in supply.

10. If producers must obtain higher prices that previously to produce various levels of output, the following has occurred:a. A decrease in demand.b. An increase in demand.c. A decrease in supply.d. An increase in supply.

11. An improvement in production technology will:a. Increase equilibrium price.b. Shift the supply curve to the left.c. Shift the supply curve to the right.d. Shift the demand curve to the left.

12. The location of the supply curve of a product depends on:

a. The technology used to produce it.

b. The prices of resources used in its production.c. The number of sellers in the market.d. All of the above.

13. When the price of oil declines significantly, the price of gasoline also declines. The latter occurs because of a(n):a. Increase in the demand for gasoline.b. Decrease in the demand for gasoline.c. Increase in the supply of gasoline.d. Decrease in the supply of gasoline.

14. An increase in the excise tax on cigarettes raises the price of cigarettes by shifting the:a. Demand curve for cigarettes rightward.b. Demand curve for cigarettes leftward.c. Supply curve for cigarettes rightward.d. Supply curve for cigarettes leftward.

15. A government subsidy to the producers of a product:a. Reduces product supply.b. Increases product supply.c. Reduces product demand.d. Increases product demand.

True/False Questions:

1. A change in the quantity demanded describes a movement along a given demand curve in response to a change in the price of the good.

2. A change in demand shifts the entire demand curve. An increase in demand shifts the demand curve to the left; a decrease shifts it to the right.

3. A change in the price of a substitute shifts the demand curve for the good in question. The relationship is direct.

4. Changes in taste will not shift the demand curve. Changes in expected future prices and income can shift the current demand curve.

5. Input prices, the prices of substitutes in production, expectations, the number of suppliers, technology, regulation, taxes and subsidies, and weather can all lead to changes in quantity supplied.

6. The supply of a good increases (decreases) if the price of one of its substitutes in production falls (rises).

7. The important point about a market is what it doest – it facilitates trade.8. An inverse, or negative, relationship is one where one variable changes in the opposite direction

from the other – if one increases, the other decreases.9. Supply may also change because of changes in the legal and regulatory environment in which firms

operate.10. When teenagers get their driver’s licenses, their increased mobility expands their alternatives to

baby-sitting substantially, raising the opportunity cost of baby-sitting. This change decreases (shift left) the supply of baby-sitting services.

Fill in the blanks:

1. A(n) _____ is the process of buyers and sellers _____ goods and services.2. _____, as a group, determine the demand side of the market. _____, as a group, determine the

supply side of the market.3. An increase in demand is represented by a _____ shift in the demand curve; a decrease in demand is

represented by a _____ shift in the demand curve.4. The market supply curve is a graphical representation of the amount of goods and services that

suppliers are _____ and ______ to supply at various prices.5. The supply of a good _____ if the price of one of its substitutes in production falls. The supply of a

good _____ if the price of one of its substitutes in production rises.

WEB EXERCISE (5 POINTS)

IMAGINE GETTING PAID SEARCHING THE NET

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REFERENCES

Case, Karl and Fair, Ray. (2002). Principles of Economics (6th ed.). USA: Prentice Hall.

Mankiw, Gregory. (2002). Principles of Economics (2nd ed.). Forth Worth, Texas: South-Western/Thomson.

McConnell, Campbell R. and Brue, Stanley L. (2002). Economics: Principles, Problems, and Policies (15th ed.). New York, NY: McGraw-Hill Companies, Inc.

Samuelson, Paul and Nordhaus, William. (2005). Economics (18th ed.). USA: McGraw-Hill.

Stiglitz, Joseph E. and Walsh, Carl E. (2002). Economics (3rd ed.). New York, NY: WW Norton and Company, Inc.

ABOUT THE AUTHORS

Dr. Aileen L. Camba and Dr. Abraham C. Camba Jr. are a wife-and-husband duo. They are dedicated to the challenge of explaining Economics and Finance ever more clearly to an ever-growing body of students. They are passionate about their subjects and about the free expression of blogging. Please visit their weblogs:

http://quantcrunchtutor.blogspot.com http://get-globaleconomictrends.blogspot.com http://tourism7aroundworld.blogspot.com http://homebusinessinternetlifestyle.blogspot.com

They can be reached at (632)517-5785 or (63)9056648384, or email them at [email protected].

Therefore, whether you eat or drink, or whatever you do, do all to the glory of God.

- 1 Corinthians 10:31