Supply and demand: flashcards, quiz and summary

Flashcards

1. 1Why does the demand curve slope downward?

   When price rises, quantity demanded falls, all else equal. Buyers switch to cheaper substitutes, and a given amount of money buys less, so they purchase less.

2. 2What is the difference between a change in demand and a change in quantity demanded?

   A change in quantity demanded is a movement along the same demand curve caused by a change in the good's own price. A change in demand is a shift of the whole curve caused by something else, such as income or tastes.

3. 3Which non-price factors shift the demand curve, and in which direction does each push it?

   Income, related goods, expectations, tastes, and the number of buyers. More income raises demand for normal goods and lowers it for inferior goods. A rise in the price of a substitute raises demand for the other good, and a rise in the price of a complement lowers it.

4. 4What happens to price and quantity when supply decreases?

   Price rises and quantity falls, because the supply curve shifts left and the new equilibrium lies at a higher price and lower quantity.

5. 5How do you find the equilibrium price and quantity from demand and supply equations?

   Set quantity demanded equal to quantity supplied, solve for price, then substitute that price into either equation to find the quantity. In the lemonade example, 120 minus 20P equals 20P gives P = 3 and Q = 60.

6. 6Why does a price ceiling cause a shortage only when it is set below equilibrium?

   A ceiling set above equilibrium is not binding, because the market already clears below it. A ceiling below equilibrium means buyers want more than sellers offer at that price, which creates a shortage.

7. 7Why does a price below equilibrium push the price up?

   At a price below equilibrium, buyers want more than sellers offer, so some buyers compete for the limited supply and are willing to pay more. That pressure moves the price up toward equilibrium.

8. 8How does elasticity determine what happens to total revenue when price rises?

   If demand is inelastic, quantity falls by a smaller percent than price rises, so total revenue rises. If demand is elastic, quantity falls by a larger percent, so total revenue falls.

9. 9How do substitutes and complements affect demand for related goods?

   Substitutes move in the same direction: if the price of coffee rises, demand for tea rises. Complements move in the opposite direction: if the price of tortilla chips rises, demand for salsa falls.

10. 10What causes the supply curve to shift right?

    Cheaper inputs, better technology, subsidies, more sellers, or favorable weather for crops. Each lets firms offer more at every price.

Practice quiz

Pick an answer to check it.

1. 1The price of coffee rises. What happens to the demand curve for tea, a substitute for coffee?

   1. It shifts left, because tea and coffee are complements
   2. It moves down along the same curve as buyers want more tea at a lower price
   3. It shifts right, because buyers want more tea
   4. It does not move, because only tea's own price affects its demand
   Show the answer

   C. It shifts right, because buyers want more tea Substitutes are goods people switch between. When coffee gets more expensive, more buyers want tea at every price, so the whole demand curve for tea shifts right. Complements are goods used together, which is a different relationship.

2. 2In the lemonade market, Qd = 120 minus 20P and Qs = 20P. If the price is set at a ceiling of $2, how large is the shortage?

   1. 80 cups
   2. 20 cups
   3. 40 cups
   4. 60 cups
   Show the answer

   C. 40 cups At P = 2, quantity demanded is 120 minus 40, or 80 cups, and quantity supplied is 40 cups. The gap of 40 cups is the shortage.

3. 3A product's price rises from $10 to $12, which is a 20 percent increase. Quantity demanded falls by 10 percent. What is the price elasticity of demand?

   1. 0.2
   2. 1.0
   3. 2.0
   4. 0.5
   Show the answer

   D. 0.5 Elasticity equals the percent change in quantity demanded divided by the percent change in price, so 10 divided by 20 equals 0.5. Since that is less than 1, demand is inelastic.

4. 4Which change shifts the supply curve to the left?

   1. A subsidy paid to producers for each unit made
   2. A tax placed on each unit sold
   3. A new technology that cuts production costs
   4. A fall in the price of the good
   Show the answer

   B. A tax placed on each unit sold A tax raises the cost of selling, so sellers offer less at every price and the supply curve shifts left. A subsidy and new technology both shift supply right. A change in the good's own price moves along the curve rather than shifting it.

5. 5A city sets a legal maximum rent below the market equilibrium rent. What is the most likely result?

   1. A shortage of apartments
   2. A higher equilibrium rent
   3. A surplus of apartments
   4. No change in the number of apartments rented
   Show the answer

   A. A shortage of apartments A price ceiling below equilibrium means landlords offer fewer apartments than renters want at that price, which creates a shortage. A surplus would require a price floor above equilibrium.

6. 6In the basic supply and demand model, a minimum wage is set above the equilibrium wage. What happens in the labor market?

   1. The quantity of labor demanded rises
   2. Wages fall to the equilibrium level
   3. A shortage of jobs
   4. A surplus of workers
   Show the answer

   D. A surplus of workers A floor above equilibrium means more people want to work at that wage than employers want to hire, creating a surplus of workers. Employers demand less labor at a higher wage, not more.

7. 7What happens when the price of a good itself changes, with nothing else changing?

   1. The market moves along the same demand curve to a new quantity demanded
   2. Its demand curve shifts right
   3. Quantity demanded stays the same
   4. Its demand curve shifts left
   Show the answer

   A. The market moves along the same demand curve to a new quantity demanded A change in a good's own price changes quantity demanded, which is a movement along the existing curve. Only factors other than the good's own price shift the whole demand curve.

Test traps

What teachers like to test on this, and the mistakes students make.

• Confusing a change in quantity demanded with a change in demand: a price change moves along the curve, while income, tastes, or related prices shift the whole curve.
• Saying a good's own price change shifts its demand curve, when it only moves the market along the existing curve.
• Mixing up the direction of a substitute and a complement: substitutes move demand in the same direction as the other good's price, while complements move it in the opposite direction.
• Drawing a price ceiling or floor on the wrong side of equilibrium: a ceiling only binds below equilibrium and a floor only binds above it, so a non-binding control has no effect.
• Reading a supply shift as a movement along the curve, or mixing up which direction a shift to the left or right goes.
• Calculating elasticity without using percent changes, or forgetting to drop the minus sign, and then misreading whether demand is elastic or inelastic when deciding what happens to revenue.

Summary

• Demand slopes downward: when price rises, quantity demanded falls, because buyers switch to substitutes and their money buys less.
• Supply slopes upward: when price rises, quantity supplied rises, because higher prices mean more profit for firms.
• A change in a good's own price moves the market along the curve, while anything else, such as income, input costs, or taxes, shifts the whole curve.
• Equilibrium is where quantity demanded equals quantity supplied; a price below it causes a shortage and a price above it causes a surplus, and both push price back toward equilibrium.
• A price ceiling only matters when it is set below equilibrium, where it causes a shortage, and a price floor only matters when it is set above equilibrium, where it causes a surplus.
• Price elasticity of demand measures how strongly quantity demanded responds to a price change; when demand is inelastic, raising the price raises total revenue, and when it is elastic, raising the price lowers total revenue.

Key terms

Demand

How much buyers are willing and able to buy at each possible price.

Quantity demanded

The amount buyers purchase at one specific price, shown as a single point on the demand curve.

Law of demand

When the price of a good rises, the quantity demanded falls, all else equal.

Equilibrium

The price and quantity where the supply and demand curves cross, so quantity demanded equals quantity supplied.

Price ceiling

A legal maximum price. It causes a shortage only when it is set below the equilibrium price.

Price elasticity of demand

How strongly quantity demanded reacts to a change in price, calculated as the percent change in quantity demanded divided by the percent change in price, ignoring the minus sign.

How to study it

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Questions