Demand and Supply
Demand and Supply Knowledge Summary: • Demand is usually downward sloping and Supply upward sloping • Intersection of Demand and Supply curves is the equilibrium point • Change in quantity demanded/quantity supplied are movements along the demand/supply curve and change in the demand/supply is a shift of the demand/supply curve. • The Demand/Supply Curve is the sum of Individual demand/supply of the product. • Factors that shift demand: 1. Taxes/Subsidies. 2. Change in Prices of related goods (Substitutes/Complimentary Goods) 3. Change in Income 4. Change in Preferences • Factors That Shift Supply 1. Prices of Inputs (As prices rise, Supply falls) 2. No. of Firms (As firms rise, Supply Rises) 3. Technology ( A new breakthrough increases supply) 4. Taxes/Subsidies • Consumer Surplus: The value of the goods to the consumer above and beyond the market price (Area below demand curve and above price). • Producer Surplus: The Difference in the amount that a producer actually receives for a product and what they are willing to receive for it (Area above supply curve and below price). Summary of Questions to be Asked: 1. Plot the Demand/Supply of a Good: -‐Sum up the Individual Demand/Supply at Various Prices. -‐Plot the new data as the Demand/Supply curve 2. Find Changes in the Equilibrium Quantity and Price: -‐ Locate the original equilibrium point ‘e1’ (Intersection of original demand and supply curves). -‐ Locate the new equilibrium ’e2’ (Intersection of demand and supply after a proposed change). -‐ Find the difference between the Quantity and Price of the two points
(e1-‐e2). 3. Find New Demand Curve after: i) Tax/Subsidy -‐ Tax/Subsidy causes a upward/downward shift in the demand by the amount of the tax /subsidy. (Note: Shift is vertically calculated) ii) Change in Price of Related Goods. -‐ Complimentary goods: Goods that complement each other. (e.g gasoline and cars) -‐ If the Price of a Complimentary goods Rises/Falls the demand of the Product Falls/Rises. -‐Substitute Goods: Goods that may substitute each other. (e.g houses and apartments) -‐If the Price of a Substitute Good Falls/Rises the Demand of the Product Falls/Rises. iii) Change in Income: -‐If income Rises/Falls, Demand Rises/Falls. 4. Find the new Supply Curve After: i) Tax/Subsidy -‐ Tax/Subsidy causes a downward/upward shift in the Supply by the amount of the tax /subsidy. (Note: Shift is vertically calculated) 5. Find the Consumer and Producer Surplus i) For Consumer Surplus (CS), find the area of the triangle that forms between the demand curve, the equilibrium point and the price. -‐ Note: When Price Elasticity of Demand (PED) is infinite, CS=0. When PED =0, CS is infinite. When PES=0/infinite, CS=0/Infinite ii) For Produce Surplus (PS), find the area of the triangle that forms between the Supply curve, the equilibrium point and the price. -‐ Note: When Price Elasticity of Demand (PED) is infinite, PS is infinite. When PED =0, PS=0. When PES=0/infinite, PS=Infinite/0
Exam Questions: 2011 Term Test 1 Furlong
2011 Short Answer Q1. William Thornton criticized the supply and demand approach of economics in 1869 because a decrease in supply increases price but a decrease in price decreases supply. How does our understanding of demand and supply explain Thornton’s contradiction? Answer: A decrease in supply causes less production at every price. With less production
because of people leaving, to maintain supply, price rises. A decrease in price decreases quantity supplied because all the suppliers all-‐willing to produce less at the given price.
2011 Multiple Choice Q4. Which of the following is the effect on the equilibrium price of cars in Toronto of a simultaneous decrease in the price of car insurance and technological change that reduces the resource input in car production? a) Decrease b) Increase c) No change d) Depends on relative shift of demand and supply e) None of the above Answer: Increase in demand & Supply. Increase in demand raises price, increase in supply
decreases price. to know the final change, we need to know their relative shift. So, it depends on relative shift.
2011 Multiple Choice Q5 Which of the following is the effect on the equilibrium Quantity of cars in Toronto of a simultaneous decrease in the price of car insurance and technological change that reduces the resource input in car production? a) Decrease b) Increase c) No change d) Depends on relative shift of demand and supply e) None of the above Answer: Increase in demand & Supply. increase in demand raises quantity, increase in
supply also increases quantity. Hence, Quantity increases.
2009 Multiple Choice Q1. Which of the following will increase the Price and decrease the Quantity of Airline Passenger Tickets in the next few months? a.
An economic recovery that drives up incomes
b.
Continued economic recession that reduces incomes
c.
An increase in the price of inflight meals charged separate from the ticket
d.
A decrease in the number of flights offered
e.
None of the above
Answer: Decrease in supply increases price and decreases quantity. decrease in number of
flights offered means a decrease in supply. 2009 Multiple Choice Q2. What is the effect on the equilibrium price and quantity of corn of an increase in the price of ethanol (a good made from corn) and a bad harvest this fall? f.
Equilibrium price and quantity will both fall
g.
Equilibrium price will fall and equilibrium quantity will rise
h.
Equilibrium price will rise and the equilibrium quantity will fall
i.
Equilibrium price and quantity will both rise
j.
Equilibrium price will rise but equilibrium quantity may rise or fall depending on the
relative shifts of the supply and demand k.
Equilibrium price will fall but equilibrium quantity may rise or fall depending on the
relative shifts of the supply and demand l.
Equilibrium quantity will rise but equilibrium price may rise or fall depending on the
relative shifts of the supply and demand m.
Equilibrium quantity will fall but equilibrium price may rise or fall depending on the
relative shifts of the supply and demand n.
No change in either equilibrium quantity or equilibrium price
o.
We have insufficient information to determine the effect on price or quantity
Corn and ethanol are complements in production. Increase in ethanol price and bad harvest will cause an increase in demand and decrease in supply. Demand increase and supply decrease both move price upwards but move quantity in opposite directions. Answer:
2011 Short Answer Q2. Why are we able to say that linear demand is inelastic relative to linear supply at equilibrium when the slope of demand is greater than the slope of supply?
Because elasticity is % age change. Hence, the original p and q matter. E = (change in q/change in p) * (p/q). So down the demand curve, p falls and q rises, so elasticity starts falling. Answer:
2012 Short Answer Q1. What is the modern definition of demand? Answer: Demand is the Quantity that people require for a given price. Only the people who
are willing and able to buy those goods may register demand
2012 Short Answer Q2. Briefly explain the mechanism that brings about competitive equilibrium in markets without government intervention. Answer: Demand and supply. For a given price, quantity demanded must equal quantity
supplied. If Qs>Qd, there may be unsold material so suppliers bid down the price till Qd=Qs. If Qs,Qd, there is shortage and customers bid up the price until Qd=Qs. hence, equilibrium is reached.
2012 Multiple Choice Q3 Suppose that incomes of buyers in the market for a normal good decline and there is a reduction in input prices a.
equilibrium price will increase but the impact on equilibrium quantity is ambiguous
b.
equilibrium price will decrease but the impact on equilibrium quantity is ambiguous
c.
both equilibrium price and equilibrium quantity will increase
d.
equilibrium quantity will increase but the impact on equilibrium price is ambiguous
e.
equilibrium quantity will decrease but the impact on equilibrium price is ambiguous
Answer: Demand falls, supply rises. Fall in demand and rise in supply both drop price.
However, both move Q in opposite directions. As we don not know the magnitudes of the relative shift, Price definitely falls and Q is ambigious.
(e1-‐e2). 3. Find New Demand Curve after: i) Tax/Subsidy -‐ Tax/Subsidy causes a upward/downward shift in the demand by the amount of the tax /subsidy. (Note: Shift is vertically calculated) ii) Change in Price of Related Goods. -‐ Complimentary goods: Goods that complement each other. (e.g gasoline and cars) -‐ If the Price of a Complimentary goods Rises/Falls the demand of the Product Falls/Rises. -‐Substitute Goods: Goods that may substitute each other. (e.g houses and apartments) -‐If the Price of a Substitute Good Falls/Rises the Demand of the Product Falls/Rises. iii) Change in Income: -‐If income Rises/Falls, Demand Rises/Falls. 4. Find the new Supply Curve After: i) Tax/Subsidy -‐ Tax/Subsidy causes a downward/upward shift in the Supply by the amount of the tax /subsidy. (Note: Shift is vertically calculated) 5. Find the Consumer and Producer Surplus i) For Consumer Surplus (CS), find the area of the triangle that forms between the demand curve, the equilibrium point and the price. -‐ Note: When Price Elasticity of Demand (PED) is infinite, CS=0. When PED =0, CS is infinite. When PES=0/infinite, CS=0/Infinite ii) For Produce Surplus (PS), find the area of the triangle that forms between the Supply curve, the equilibrium point and the price. -‐ Note: When Price Elasticity of Demand (PED) is infinite, PS is infinite. When PED =0, PS=0. When PES=0/infinite, PS=Infinite/0
Exam Questions: 2011 Term Test 1 Furlong
2011 Short Answer Q1. William Thornton criticized the supply and demand approach of economics in 1869 because a decrease in supply increases price but a decrease in price decreases supply. How does our understanding of demand and supply explain Thornton’s contradiction? Answer: A decrease in supply causes less production at every price. With less production
because of people leaving, to maintain supply, price rises. A decrease in price decreases quantity supplied because all the suppliers all-‐willing to produce less at the given price.
2011 Multiple Choice Q4. Which of the following is the effect on the equilibrium price of cars in Toronto of a simultaneous decrease in the price of car insurance and technological change that reduces the resource input in car production? a) Decrease b) Increase c) No change d) Depends on relative shift of demand and supply e) None of the above Answer: Increase in demand & Supply. Increase in demand raises price, increase in supply
decreases price. to know the final change, we need to know their relative shift. So, it depends on relative shift.
2011 Multiple Choice Q5 Which of the following is the effect on the equilibrium Quantity of cars in Toronto of a simultaneous decrease in the price of car insurance and technological change that reduces the resource input in car production? a) Decrease b) Increase c) No change d) Depends on relative shift of demand and supply e) None of the above Answer: Increase in demand & Supply. increase in demand raises quantity, increase in
supply also increases quantity. Hence, Quantity increases.
2009 Multiple Choice Q1. Which of the following will increase the Price and decrease the Quantity of Airline Passenger Tickets in the next few months? a.
An economic recovery that drives up incomes
b.
Continued economic recession that reduces incomes
c.
An increase in the price of inflight meals charged separate from the ticket
d.
A decrease in the number of flights offered
e.
None of the above
Answer: Decrease in supply increases price and decreases quantity. decrease in number of
flights offered means a decrease in supply. 2009 Multiple Choice Q2. What is the effect on the equilibrium price and quantity of corn of an increase in the price of ethanol (a good made from corn) and a bad harvest this fall? f.
Equilibrium price and quantity will both fall
g.
Equilibrium price will fall and equilibrium quantity will rise
h.
Equilibrium price will rise and the equilibrium quantity will fall
i.
Equilibrium price and quantity will both rise
j.
Equilibrium price will rise but equilibrium quantity may rise or fall depending on the
relative shifts of the supply and demand k.
Equilibrium price will fall but equilibrium quantity may rise or fall depending on the
relative shifts of the supply and demand l.
Equilibrium quantity will rise but equilibrium price may rise or fall depending on the
relative shifts of the supply and demand m.
Equilibrium quantity will fall but equilibrium price may rise or fall depending on the
relative shifts of the supply and demand n.
No change in either equilibrium quantity or equilibrium price
o.
We have insufficient information to determine the effect on price or quantity
Corn and ethanol are complements in production. Increase in ethanol price and bad harvest will cause an increase in demand and decrease in supply. Demand increase and supply decrease both move price upwards but move quantity in opposite directions. Answer:
2011 Short Answer Q2. Why are we able to say that linear demand is inelastic relative to linear supply at equilibrium when the slope of demand is greater than the slope of supply?
Because elasticity is % age change. Hence, the original p and q matter. E = (change in q/change in p) * (p/q). So down the demand curve, p falls and q rises, so elasticity starts falling. Answer:
2012 Short Answer Q1. What is the modern definition of demand? Answer: Demand is the Quantity that people require for a given price. Only the people who
are willing and able to buy those goods may register demand
2012 Short Answer Q2. Briefly explain the mechanism that brings about competitive equilibrium in markets without government intervention. Answer: Demand and supply. For a given price, quantity demanded must equal quantity
supplied. If Qs>Qd, there may be unsold material so suppliers bid down the price till Qd=Qs. If Qs,Qd, there is shortage and customers bid up the price until Qd=Qs. hence, equilibrium is reached.
2012 Multiple Choice Q3 Suppose that incomes of buyers in the market for a normal good decline and there is a reduction in input prices a.
equilibrium price will increase but the impact on equilibrium quantity is ambiguous
b.
equilibrium price will decrease but the impact on equilibrium quantity is ambiguous
c.
both equilibrium price and equilibrium quantity will increase
d.
equilibrium quantity will increase but the impact on equilibrium price is ambiguous
e.
equilibrium quantity will decrease but the impact on equilibrium price is ambiguous
Answer: Demand falls, supply rises. Fall in demand and rise in supply both drop price.
However, both move Q in opposite directions. As we don not know the magnitudes of the relative shift, Price definitely falls and Q is ambigious.
