INTRODUCTION TO ECONOMICS By stewart Mbegu and Kulwa Guyashi

DEMAND, SUPPLY, AND EQUILIBRIUM PRICES

Supply and demand is an economic model based on price, utility and quantity in a market. It concludes that in a competitive market, price will function to equalize the quantity demanded by consumers, and the quantity supplied by producers, resulting in an economic equilibrium of price and quantity. Similarly, an increase in the number of workers tends to result in lower wages and vice-versa. The model incorporates other factors changing equilibrium as a shift of demand and/or supply.

DEMAND

In microeconomic theory, demand is defined as the willingness and ability of a consumer to purchase a given product in a given frame of time and price.

OR
Demand is the willingness and ability of a consumer to buy a commodity at a given price.

The willingness and ability of a consumer to buy a commodity at a given price is sometimes known as Effective demand.

Demand is the relationship that showing the various amounts of a commodity that the buyers would be willing and able to buy possible alternative prices during a given period of time when all other things are also the determinant of demand other than the price of the commodity remains constant.

DETERMINANTS OF DEMAND

The main determinants of individual demand are: the price of the goods, level of income, personal tastes, the population (number of people), the government policies, the price of substitute goods, and the price of complementary goods.

DEMAND FUNCTION
Demand function is a mathematical notation which shows the relationship between the quantity and its determinants.

Dx  =   f (Px, Po, Y, T )

Where by:  Px is price of goods

Dx is the demand of goods                                                                                                                Y is a consumer income                                                                                              T is consumer taste and fashion                                                                                 Po is the price of related goods

For basic analysis, the demand curve often is approximated as a straight line. A demand function can be written to describe the demand curve. Demand functions for a straight-line demand curve take the following form:

Quantity = a - (b x Price)

Where a and b are constants that must be determined for each particular demand curve.
When price changes, the result is a change in quantity demanded as one moves along the demand curve.    

INTER-RELATED DEMANDS

When the demand for one commodity is affected by the changes in the demand of other commodities.
JOINT DEMAND
Goods demanded jointly.  If two or more goods are demanded together then these have a joint or complimentary demand. E.g. motor car and petrol.
COMPETITIVE DEMAND
For substitute goods e.g. Tea and coffee such that the increase in demand of tea will result into the decrease in demand for coffee and vice versa is true.
COMPOSITE DEMAND

For goods which are used for different purposes. The total demand for such goods for all uses is known as composite demand eg. Steel for manufacture of cars, machines and buildings materials.

DERIVED DEMAND
The demand of goods in order to produce some other good e.g. Cotton required to produce cloth.
DIRECT DEMAND
Demand for the goods by the consumer for satisfying their wants e.g. demand for food and cloth.

DEMAND SCHEDULE

Demand schedule is table that contains experimentally obtained information of buying habits at varied prices. From these data a demand curve is then estimated and graphed, usually with the amount of a good or service demanded graphed to the x axis (often named in equations as "Q") and the price at which the good or service would be purchased on the y axis (often named in equations as "P").

OR

The demand schedule, depicted graphically as the demand curve, represents the amount of goods that buyers are willing and able to purchase at various prices, assuming all other non-price factors remain the same. The quantity demanded of a good usually is a strong function of its price. Suppose an experiment is run to determine the quantity demanded of a particular product at different price levels, holding everything else constant. Presenting the data in tabular form would result in a demand schedule, an example of which is shown below.

Demand Schedule

Price(Tshs)	Quantity Demanded Maize Bags
5	10
4	17
3	26
2	38
1	53

DEMAND CURVE

Demand curve can be defined as the graph depicting the relationship between the price of a certain commodity, and the amount of it that consumers are willing and able to purchase at that given price. It is a graphic representation of a demand schedule. The demand curve for all consumers together follows from the demand curve of every individual consumer: the individual demands at each price are added together.

Demand curves are used to estimate behaviors in competitive markets, and are often combined with supply curves to estimate the equilibrium price (the price at which sellers together are willing to sell the same amount as buyers together are willing to buy, also known as market clearing price) and the equilibrium quantity (the amount of that good or service that will be produced and bought without surplus/excess supply or shortage/excess demand) of that market

   The demand curve for this example is obtained by plotting the data:

Demand Curve

By convention, the demand curve displays quantity demanded as the independent variable (the x axis) and price as the dependent variable (the y axis).

LAW OF DEMAND

According to the law of demand, the higher the price, the low quantity to be demanded and the low the price the higher quantity to be demanded.

The quantity demanded of a good varies inversely with its prices assuming that all other things which may affect demand especially the buyers’ income, tastes, population, and the prices of other commodities remain the same.

Inversely means that as the price of goods decreases, the corresponding quantity demanded increases and when the prices of goods increases, the corresponding quantity demanded decreases. Try to see the demand schedule and demand curve to understand well about this law of demand.

Reasons For the Law of Demand to operate as it does

If the price of a good decreases people can afford to buy more of it and if their income, taste, population, and the prices of other goods remain the same.

When the price of a product is reduced, people may buy more of it because it becomes a better bargaining than other goods.  The downward sloping of the demand curve tells us that people would be willing to pay a relatively high price for a small amount of something but the more you have of it the less you would care to buy for one more unit because each extra unit gives less additional satisfaction or utility than the previous units.

EXCEPTIONS OF THE LAW OF DEMAND

Exception of law of demand referring to some limitations for the law of demand to operate, these exceptions or limitations include the following:                                                                                                                                                                         

GIFFEN GOOD

A Giffen good is one which people consume more of as price rises, violating the law of demand. In normal situations, as the price of such a good rises, the substitution effect causes people to purchase less of it and more of substitute goods.

VEBLEN GOODS

These are many goods like jewellery, clothing, and original works of arts.  If these are put at low prices, they will lack lack demand.  If that is the case, the higher the price more will be demanded and vice versa is true and this will be against the law of demand.

IGNORANCE                                                                                                                                       In certain cases, due to ignorance about the conditions of the market, less is purchased at lower prices and more is purchased at higher prices.  In such cases also, law of Demand does not apply.

ABNORMAL DEMAND CURVE

It occurs when the demand curves move from left to right upward.  It means when the prices rise, the demand increase and vice versa is true.

CAUSES OF ABNORMAL DEMAND
Future price changes
If the prices is expected to rise rapidly  then even at high prices more will be demanded and vice versa is true.
Giffen good

A giffen good is one which people consume more of as price rises, violating the law of demand. in normal situations, as the price of such a good rises, the substitution effect causes people to purchase less of it and more of substitute goods. in the giffen good situation, cheaper close substitutes are not available. because of the lack of substitutes, the income effect dominates, leading people to buy more of the good, even as its price rises.

Veblen goods

These are many goods like jewellery, clothing, and original works of arts.  if these are put a low prices, they will lack demand.

Note
Inferior goods:  are those goods whose demand decrease as income increase.

Normal goods:  Normal goods are any goods for which demand increases when income increases and falls when income decreases but price remains constant, i.e. with a positive income elasticity of demand. The term does not necessarily refer to the quality of the goods.

MOVEMENT ALONG THE DEMAND CURVE                                                                  (CHANGE IN QUANTITY DEMANDED)

A movement along the demand curve is caused by a change in PRICE of the good or service. For instance, a fall in the price of the good results in an EXTENSION of demand (quantity demanded will increase), whilst an increase in price causes a CONTRACTION of demand (quantity demanded will decrease).

SHIFT OF A DEMAND CURVE (CHANGE IN DEMAND)

The shift of a demand curve takes place when there is a change in the relationship between quantity and price that is brought about by a change in any of the factors influencing demand except price. A demand shift results in a new demand curve.  The curve can shift to the right or left.

A rightward shift represents an increase in the quantity demanded (at all prices), D1 to D2, whilst a leftward shift represents a decrease in the quantity demanded (at all prices). D1 to D3.

                  DEMAND CURVES

CAUSES OF SHIFT IN DEMAND CURVE                                                                           (Change in Demand)

Change in demand is caused by other factors apart from price, these factors include the flowing:

• Change in Consumer income

If consumer income increases, then consumers buy more   normal/luxury items and the demand curve shifts to the right (D1 to D2) and vice versa are true (when the income of a consumer decreases).

• Change in the price of complimentary goods

If the price of a complementary good increases then the demand for the good will fall. This will result in a leftward shift in the demand curve of any complementary good (D1 to D2) and vice versa is true. Example of complimentary goods are car and Fuel.

• Change in the price of a substitute goods

When the price of substitute goods increase then the demand for the other good would increase as consumers switch their consumption patterns (D1 to D2) and vice versa is true. Example of substitute goods is meat and fish or cocoa and coffee.

• Expectation of future price changes

If people think that prices are going to rise in the future, they are likely to buy more now before the price does go up and vice versa is true.  Example buying umbrella or rain boot before rain season because during the rain seasons the prices will be high due to high demand, therefore the demand curve will shift to right.

• Change in Fashion

When there is invention of a new product and introduced into the market, people will shift to a new product and leave the old so as to move with the fashion, if that is the case the demand for the old products will be less which make the demand curve to shift to left(f rom D1 to D3) and the demand curve for a new product will shift to right (from D1 to D2).

·         Changes in tastes

The more desirable people find the good, the more they will demand. If a taste of a product is    becoming good then people will switch to that product and its demand curve will shift to right and vice versa is true.  Tastes are affected by advertising, fashions, observing other consumers.

• Population change

When population of people change the demand of various commodities is also affected.  When the population increases, the demand of a commodity also increases despite the fact that the price remains constant and vice versa is true. Therefore, this will cause a shift in demand curve to right or left.

INDIVIDUAL DEMAND AND MARKET DEMAND

We now have a theory of the individual's demand curve. The theory tells us that the individual's demand curve is identical with the individual's marginal benefit curve. But, for supply and demand analysis, we need the market demand curve. the market demand is the sum of the amounts demanded by each of the individuals. That is, the market demand is the horizontal sum of the individual demands. The market demand is obtained by adding up all the individual demand for the commodities

                            

 

 

 

 

 

                             Individual and Market Demand Curves

The diagram shows individual demand curves for Tom, Dick and Harry. The thick gray line is the demand curve for a market consisting of Tom, Dick and Harry.

In market equilibrium, Tom, Dick and Harry will each pay the same price and adjust their purchases to the price. Each will be paying a price equal to his own marginal benefit. Thus

1. The marginal benefit is the same for each of the consumers who buys the product.
2. The market price measures the marginal benefit of one more unit of production, whoever may buy it. We can see from this that the fundamental principle of consumers' demand applies to the market as a whole just as it applies to an individual consumer.

Demand shortfalls

A demand shortfall results from the actual demand for a given product being lower than the projected, or estimated, demand for that product. Demand shortfalls are caused by changes in prices, change in taste and fashion, and change in prices of substitute and complimentary goods etc.

SUPPLY

Supply is the willingness and ability of a producer to make a certain specific quantity of output available to the consumers at a particular price over a given period of time.

The willingness and ability is referred to as Effective supply.

It is the quantity of commodity that suppliers will wish to supply at a particular price.  It is the quantity of any commodity which is offered for sale at any specific price.

Determinants of Supply

Determinants of supply we are referring to all other factors apart from price that may cause a change in supply of goods.  These factors include the following:

Change in costs of production - if the costs of production increase then the       potential profit will fall. This will cause producers to look at alternative goods to produce. Therefore, an increase in the costs of production will cause a leftward shift in the supply curve.

Role of technology - if the degree of technology employed in production increases then firms will be able to make more goods with their given level of inputs (factors of production). Therefore, an improvement in technology causes the supply curve to shift to the right.

Prices of other goods - the supply of one good may decrease if the price of another good increases, causing producers to reallocate resources to produce larger quantities of the more profitable good.

Number of sellers - more sellers result in more supply, shifting the supply curve to the right.

Prices of relevant inputs - if the cost of resources used to produce good increases, sellers will be less inclined to supply the same quantity at a given price, and the supply curve will shift to the left.

Technology - technological advances that increase production efficiency shift the supply curve to the right.

Price Expectations - if sellers expect prices to increase, they may decrease the quantity currently supplied at a given price in order to be able to supply more when the price increases, resulting in a supply curve shift to the left.

Profitability of alternative products (Substitute in supply) -If a product which is a substitute in supply becomes profitable to supply than the other, producers are likely to switch from the first good to the alternative, supply of the first product will fall and vice versa is true.

The profitability of goods in joint supply -This is when one good is produced in joint another good is also produced at the same time.  So goods in joint supply are the ones where the production of more of one leads to production of more of the other.  Therefore if more petrol is produced due to a rise in demand hence its price then the supply of other fuels will rise too and vice versa is true.

Development of means of transport and communication -If means of transport and communication are adequate and developed, it will be possible to move commodities from one place to another therefore supply will rise due to smooth movement of goods and people.

Climatic Situation - If climatic situation remain favourable, agricultural production will increase and as a result of this supply will rise and vice versa is true.

Peace and Security - During peace and security, supply rises because production is encouraged and vice versa is true.

Policy of the government - When restrictions are levied by the government on the movement of the commodities, supply will fall and when such restrictions are removed supply will rise. The government can hinder the movement of some goods by using various ways such as imposing high taxes, total ban for economic, health, social and political reasons.

INTER-RELATED SUPPLY

Ø  Joint supply

Ø  Competitive supply

Ø  Composite supply

JOINT SUPPLY

This involves goods in which the production of one or variations in the amount of the good produced automatically affected by the supply of products

COMPETITIVE SUPPLY

This involves goods which have an important raw material in common.  Thus liquid milk can be turned into either cheese or butter and an increase in the amount of cheese produced from a given quantity of milk may reduce the supply of butter.

COMPOSITE SUPPLY

For substitute goods whose total quantity supplied is called a composite supply. E.g. tea and coffee, coca cola and Pepsi.

SUPPLY FUNCTION

Supply function is the function which shows the relationship between the price and the quantity supplied at the given period of time. i.e it explains that there is a direct relationship between the quantity supplied and the prices of commodity

Mathematically, the supply function can be as follows:

Quantity = a + (b x Price)

where a and b are constant for each supply curve.

A change in price results in a change in quantity supplied and represents movement along the supply curve.

SUPPLY SCHEDULE

Supply schedule is a table showing the different quantities of a good that producers are willing and able to supply at various prices over a given time period.

A supply schedule can be for an individual producer or group of producers or of all producers

Supply Schedule

Price	Quantity Supplied
1	12
2	28
3	42
4	52
5	60

SUPPLY CURVE

Supply curve is a graph showing the relationship between the price of a good and the quantity of the good supplied over a given period of time.

By graphing the data, one obtains the supply curve as shown below:

Supply Curve

The convention of the supply curve is to display quantity supplied on the x-axis as the independent variable and price on the y-axis as the dependent variable.

LAW OF SUPPLY

The law of supply states that the higher the price, the larger the quantity supplied, all other things remain constant. Other things to remain constant are all those factors that cause a change in supply e.g. Prices of complintary and substitute goods, government policies, climate, cost of production etc. The law of supply is demonstrated by the upward slope of the supply curve.

More illustration of this law just sees the supply schedule and supply curve.

MOVEMENT ALONG SUPPLY CURVE                                                                           (CHANGE IN QUANTITY SUPPLIED)

A movement along the supply curve is caused by a change in PRICE of the good or service. For instance, an increase in the price of the good results in an EXTENSION of supply (quantity supplied will increase), whilst a decrease in price causes a CONTRACTION of supply (quantity supplied will decrease) as you can see from the illustration below.

Illustration

A SHIFT in the supply curve (Change in Quantity Demanded)

While changes in price result in movement along the supply curve, changes in other relevant factors cause a shift in supply, that is, a shift of the supply curve to the left or right. Such a shift results in a change in quantity supplied for a given price level. If the change causes an increase in the quantity supplied at each price.

A shift in the supply curve is caused by a change in any non-price determinant of supply. The curve can shift to the right or left. A rightward shift represents an increase in the quantity supplied (at the same price) S1 to S2, whilst a leftward shift represents a decrease in the quantity supplied (at the same price). S1 to S3.   Illustration below

INDIVIDUAL SUPPLY AND MARKET SUPPLY

Individual supply show how much of a commodity individual producer or a group of producers are able and willing to supply a product into the market at a certain price in a given period of time while market (Aggregate supply) shows how much of a commodity all the producers in the market will be able and willing to supply at a certain price and in a given period of time.  Aggregate supply is obtained by summing up individual supply.

EQUILIBRIUM POINT

Equilibrium point is where the two curves intersect.  It is a position of balance between demand curve and supply curve. A position in which there is no inherent tendency to move away.

EQUILIBRIUM PRICE

The price where the price of quantity demanded is equal to the price quantity supplied the price where there is no shortage or surplus.  It is the price at which the wishes of buyers and sellers coincide.

EQUILIBRIUM QUANTITY

It is the point where by the quantity demanded is equal to the quantity supplied

Illustration of Equilibrium point

Price of market balance:

• P - price
• Q - quantity of good
• S - supply
• D - demand
• P0 - price of market balance
• A - surplus of demand - when P<P0
• B - surplus of supply - when P>P0

More Elaboration on equilibrium

In the diagram, depicting simple set of supply and demand curves, the quantity demanded and supplied at price P are equal.

At any price above P supply exceeds demand, while at a price below P the quantity demanded exceeds that supplied. In other words, prices where demand and supply are out of balance are termed points of disequilibrium, creating shortages and oversupply. Changes in the conditions of demand or supply will shift the demand or supply curves. This will cause changes in the equilibrium price and quantity in the market.

Consider the following demand and supply schedule:

Price ($)	Demand	Supply
8.00	6,000	18,000
7.00	8,000	16,000
6.00	10,000	14,000
5.00	12,000	12,000
4.00	14,000	10,000
3.00	16,000	8,000
2.00	18,000	6,000
1.00	20,000	4,000

• The equilibrium price in the market is $5.00 where demand and supply are equal at 12,000 units

• If the current market price was $3.00 – there would be excess demand for 8,000 units, creating a shortage.

• If the current market price was $8.00 – there would be excess supply of 12,000 units.

When there is a shortage in the market we see that, to correct this disequilibrium, the price of the good will be increased back to a price of $5.00, thus lessening the quantity demanded and increasing the quantity supplied thus that the market is in balance.

When there is an oversupply of a good, such as when price is above $6.00, then we see that producers will decrease the price to increase the quantity demanded for the good, thus eliminating the excess and taking the market back to equilibrium.

Properties of equilibrium

When the price is above the equilibrium point there is a surplus of supply; where the price is below the equilibrium point there is a shortage in supply. Different supply curves and different demand curves have different points of economic equilibrium.

 Solving for Equilibrium Price

To solve for the equilibrium price, one must either plot the supply and demand curves, or solve for their equations being equal.

An example may be:

 

Influences changing price

A change in equilibrium price may occur through a change in either the supply or demand schedules. For instance, an increase in demand through an increase level of disposable income may produce a new demand and supply schedule, such as the following:

Price ($)	Demand	Supply
8.00	10,000	18,000
7.00	12,000	16,000
6.00	14,000	14,000
5.00	16,000	12,000
4.00	18,000	10,000
3.00	20,000	8,000
2.00	22,000	6,000
1.00	24,000	4,000

Here we see that an increase in disposable income would increase the quantity demanded of the good by 4,000 units at each price. This has the effect of changing the price at which quantity supplied equals quantity demanded. In this case we see that the two equal each other at an increased price of $6.00. This increase in demand would have the effect of shifting the demand curve rightward. Note that a decrease in disposable income would have the exact opposite effect on the equilibrium market.

We will also see similar behaviour in price when there is a change in the supply schedule, occurring through technological changes, or through changes in business costs. An increase in technology or decrease in costs would have the effect of increasing the quantity supplied at each price, thus reducing the equilibrium price. On the other hand, a decrease in technology or increase in business costs will decrease the quantity supplied at each price, thus increasing equilibrium price.

ELASTICITY

Elasticity is a central concept in the theory of supply and demand. In this context, elasticity refers to how supply and demand respond to various factors, including price as well as other stochastic principles.

OR

Elasticity can be defined as a measure of responsiveness of a variable (eg quantity demanded or quantity supplied) due to a change in one of its determinant (price or income).

OR

Elasticity is the percentage change in one variable divided by the percentage change in another variable (known as arc elasticity, which calculates the elasticity over a range of values, in contrast with point elasticity, which uses differential calculus to determine the elasticity at a specific point). It is a measure of relative changes.

Mathematical Definition of Elasticity
Elasticity = Proportionate (or percentage) change in quantity                                                                                              proportionate (or percentage) change in determinant

TYPES OF ELASTICITY

Price elasticity of demand

Price elasticity of demand (PED) is defined as the measure of responsiveness in the quantity demanded for a commodity as a result of change in price of the same commodity. It is a measure of how consumers react to a change in price. In other words, it is percentage change in quantity demanded by the percentage change in price of the same commodity. In economics and business studies, the price elasticity of demand is a measure of the sensitivity of quantity demanded to changes in price.

Mathematical definition

The formula used to calculate coefficients of price elasticity of demand for a given product is

For example, if the price moves from $1.00 to $1.05, and the quantity supplied goes from 100 pens to 102 pens, the slope is 2/0.05 or 40 pens per dollar. Since the elasticity depends on the percentages, the quantity of pens increased by 2%, and the price increased by 5%, so the price elasticity of supply is 2/5 or 0.4.

Price elasticity of supply

In economics, the price elasticity of supply is defined as a numerical measure of the responsiveness of the quantity supplied of product (A) to a change in price of product (A) alone. It is the measure of the way quantity supplied reacts to a change in price.

For example, if, in response to a 10% rise in the price of a good, the quantity supplied increases by 20%, the price elasticity of supply would be 20%/10% = 2.

When there is a relatively inelastic supply for the good the coefficient is low; when supply is highly elastic, the coefficient is high. Supply is normally more elastic in the long run than in the short run for produced goods. As spare capacity and more capital equipment can be utilized the supply can be increased, whereas in the short run only labor can be increased. Of course goods that have no labor component and are not produced cannot be expanded. Such goods are said to be "fixed" in supply and do not respond to price changes.

The quantity of goods supplied can, in the short term, be different from the amount produced, as manufacturers will have stocks which they can build up or run down.

The determinants of the price elasticity of supply are:

Ø  The existence of the naturally occurring raw materials needed for production.

Ø  The length of the production process.

Ø  The production spare capacity (the more spare capacity there is in an industry the easier it should be to increase output if the price goes up).

Ø  The time period and the factor immobility (the ease of resources to move into the industry)

Ø  The storage capacity of the merchants (if they have more goods in stock they will be able to respond to a change in price more quickly).

Income elasticity of demand (YED)

In economics, the income elasticity of demand measures the responsiveness of the demand of a good to the change in the income of the people demanding the good. It is calculated as the ratio of the percent change in demand to the percent change in income.

A negative income elasticity of demand is associated with inferior goods; an increase in income will lead to a fall in the demand and may lead to changes to more luxurious substitutes.

A positive income elasticity of demand is associated with normal goods; an increase in income will lead to a rise in demand. If income elasticity of demand of a commodity is less than 1, it is a necessity good. If the elasticity of demand is greater than 1, it is a luxury good or a superior good.

A zero income elasticity (or inelastic) demand occurs when an increase in income is not associated with a change in the demand of a good. These would be sticky goods.

Mathematical definition

YEd = Proportionate (or percentage) change in quantity                                                                                       proportionate (or percentage) change in Income

For example, if, in response to a 10% increase in income, the demand of a good increased by 20%, the income elasticity of demand would be 20%/10% = 2.

Cross elasticity of demand

In economics, the cross elasticity of demand and cross price elasticity of demand measures the responsiveness of the demand of a good A to a change in the price of another good B.

It is measured as the percentage change in demand for the first good that occurs in response to a percentage change in price of the second good.

The formula used to calculate the coefficient cross elasticity of demand is

or:

For example, if, in response to a 10% increase in the price of fuel, the demand of new cars that are fuel inefficient decreased by 20%, the cross elasticity of demand would be −20%/10% = −2.

Point-price elasticity

Point elasticity is the measurement of elasticity at a point on a curve.  The formula for the price elasticity of demand using the point elasticity of demand is:

• Point Elasticity = (% change in Quantity) / (% change in Price)
• Point Elasticity = (P ∆Q) / (Q ∆P)
• Point Elasticity = (P/Q)(∆Q/∆P) Note: In the limit (or "at the margin"), "(∆Q/∆P)" is the derivative of the demand function with respect to P. "Q" means 'Quantity' and "P" means 'Price'.

Example
Suppose a certain good (say, LaserJet printers) has a demand curve Q = 1,000 − 0.6P. We wish to determine the point-price elasticity of demand at P = 80 and P = 40. First, we take the derivative of the demand function Q with respect to P:

Next we apply the equation for point-price elasticity, namely

to the ordered pairs (40, 976) and (80, 952). We have
at P=40, point-price elasticity e = −0.6(40/976) = −0.02.
at P=80, point-price elasticity e = −0.6(80/952) = −0.05.
Arc Elasticity of demand
Arc elasticity of demand measure the elasticity between two points on a curve.
Arc Elasticity = (∆Q/Q)/(∆P/P)

THE VALUE (GREATER OR LESS THAN ONE)

Ignore the sign and concentrate on the value of the figure and tell whether the demand or supply is elastic or inelastic.
ELASTIC (Elasticity greater than 1)When quantity demanded or supplied changes more proportionate more than the determinant.
INELASTIC (Elasticity is less than 1)When the quantity demanded or supplied changes proportionately less than the determinant.
UNITARY ELASTIC ( E = 1)When the quantity demand or supplied changes proportionately the same amount as the determinant.
CATEGORIES OF ELASTICITY OF DEMAND

Perfectly inelastic (E_d = 0)

Changes in the price do not affect the quantity demanded for the good. The demand curve is a vertical straight line; this violates the law of demand.

Perfectly elastic (E_d is undefined)

 Any increase in the price, no matter how small, will cause demand for the good to drop to zero. Hence, when the price is raised, the total revenue of producers falls to zero. The demand curve is a horizontal straight line.

Relative inelastic (|E_d| < 1)

The percentage change in quantity demanded is smaller than that in price.

Relative elastic (|E_d| > 1)

The percentage change in quantity demanded is greater than that in price.

Unit elastic (or unitary elastic) (|E_d| = 1)

The percentage change in quantity is equal to that in price.

Summary of categories of elasticity of Demand and Supply

Value	Meaning
n = 0	Perfectly inelastic.
−1 < n < 0	Relatively inelastic.
n = 1	Unit (or unitary) elastic.
−∞ < n < 1	Relatively elastic.
n =  ∞	Perfectly elastic.

Determinants of elasticity of Demand

A number of factors determine the elasticity of demand as follows:

• Substitutes: The more substitutes, the higher the elasticity, as people can easily switch from one good to another if a minor price change is made              .
• Percentage of income: The higher the percentage that the product's price is of the consumer's income, the higher the elasticity, as people will be careful with purchasing the good because of its cost.                                                                                                                                                                                   
• Necessity: The more necessary a good is, the lower the elasticity, as people will attempt to buy it no matter the price, such as the case of insulin for those that need it.  
• Duration: The longer a price change holds, the higher the elasticity, as more and more people will stop demanding the goods (i.e. if you go to the supermarket and find that blueberries have doubled in price, you'll buy it because you need it this time, but next time you won't, unless the price drops back down again)

• Breadth of definition: The broader the definition, the lower the elasticity. For example, Company X's fried dumplings will have a relatively high elasticity, whereas food in general will have an extremely low elasticity (see Substitutes, Necessity above)

Elasticity and revenue

Total Revenue (TR) is the total amount of revenue gained by a seller; that is, Price X Quantity (PXQ), and is sometimes referred to as sales.

Average Revenue (AR): TR/Q, or the amount of revenue gained by the sale of 1 unit.

Marginal Revenue is the extra revenue gained by selling one more unit of a product per time period.  MR = Change in TR / Change in Q.

Businessmen can use the concept of elasticity for decision making about their sales. Sales are obtained by multiplying sales units by selling price per unit. Therefore, they use the concept of elasticity to either increase or decrease the prices of goods or supply of goods more or less goods but with the intention of increasing sales hence profit. In do so the following are decisions that will be made by considering the elasticity:

When the price elasticity of demand for a good is Relative inelastic (|E_d| < 1), the percentage change in quantity demanded is smaller than that in price. Hence, when the price is raised, the total revenue of producers rises, and vice versa.

When the price elasticity of demand for a good is Relative elastic (|E_d| > 1), the percentage change in quantity demanded is greater than that in price. Hence, when the price is raised, the total revenue of producers falls, and vice versa.

When the price elasticity of demand for a good is unit elastic (or unitary elastic) (|E_d| = 1), the percentage change in quantity is equal to that in price.

When the price elasticity of demand for a good is perfectly elastic (E_d is undefined), any increase in the price, no matter how small, will cause demand for the good to drop to zero. Hence, when the price is raised, the total revenue of producers falls to zero. The demand curve is a horizontal straight line. A banknote is the classic example of a perfectly elastic good; nobody would pay £10.01 for a £10 note, yet everyone will pay £9.99 for it.

When the price elasticity of demand for a good is perfectly inelastic (E_d = 0), changes in the price do not affect the quantity demanded for the good. The demand curve is a vertical straight line; this violates the law of demand. An example of a perfectly inelastic good is a human heart for someone who needs a transplant; neither increases nor decreases in price affect the quantity demanded (no matter what the price, a person will pay for one heart but only one; nobody would buy more than the exact amount of hearts demanded, no matter how low the price is).

NOTE: The graphs are not placed but when you are asked a question of this type remember to  the graphs of unitary elastic, perfect elastic, perfect inelastic, relative elastic and relative inelastic.

USEFULNESS OF ELASTICITY OF DEMAND                                                            (Importance of Elasticity of Demand)

FOR A CONSUMER                                                                                                                            When a consumer has to spend his income on the purchase of different commodities.  Normally a consumer spends major portion of his/her income on the purchase of those commodities which have less elastic demand.
FOR THE MONOPOLIST                                                                                                                    A monopolist can charge any price for his products because he/she has a complete control on the supply of that product.  He will charge higher prices for those commodities which have less elastic demand and vice versa is true.
FOR THE GOVERNMENT                                                                                                                   When the government imposes taxes, elasticity factor is kept in view.  The commodities which have less elastic demand if tax is imposed on these commodities government will get more income and vice versa is true.
DEVALUATION POLICY                                                                                                                      Devaluation means to lower the value of domestic currency in terms of foreign currency.  Due to devaluation, exports become cheaper for the foreigners and imports becomes expensive for the residents.  An increase in export and decrease in imports results in the improvement of the balance of payment.  It is possible only when the elasticity of demand for exports and imports is high.  

QUESTIONS FOR CONCENTRATION

1.    If the equation of the demand curve is Qd = 60 – 15P + P²                                     where Qd = Measurement in 000’ of units.  Find Point elasticity of demand if P = 3

2.    If we observe an individual to demand less of good as the price falls, we may conclude that it is an inferior good for him.  Do you agree? Explain.

3.    How large a reduction in price of a product is required to increase sales, say by 25 percent.

4.    Demand for a firm’s product has been estimated to    Qd = 1000 – 200P and if the price of product is Tshs 3 per unit, find out the price elasticity of demand at this price.

5.    What are the factors which determine price elasticity of demand?

6.    What role does price elasticity of demand play in decision making by business firms?

7.    What are the determinants of demand?

8.    What are the determinants of supply?

9.    Suppose a seller of clothes wants to lower the price of its products from shs 1500 per meet to shs 1425 per metre.  If his present sale is 2000 metres per month and further it is estimated that its elasticity of demand for the product equals to 0.7                                   

required                                                                                                                 i) Whether or not his total revenue will increase as a result of lowering the price.

ii) Calculate the exact magnitude of his new total revenue

What is importance of elasticity of demand? Given the following demand schedule:

Demand
PRICE	QUANTITY	REVENUE
15	10	____
10	55	____
5	100	____

Fill in the revenue column; without doing any further computations, is the   demand curve elastic or inelastic? Why?

Compute the coefficient of elasticity between a price of $5 and of $15 using the midpoint formula. If you have forgotten the midpoint formula.

                      Answer the below questions for the following demand schedule:

Demand schedule
PRICE	QUANTITY	REVENUE
100	100	-----
300	90	-----
500	80	-----

Given the demand curve Q = 200 - 4P

Graph the demand curve, showing exactly where it cuts the axes.

How much is demanded at a price of 10 dollars? 11 dollars? 9 dollars?

Use the above information to find the elasticity of the curve at a price of $10 that is between prices of $9 and $11. (Note: given a demand curve in algebraic form, we can find the elasticity at a point by raising and lowering the price by a dollar. We then construct a table similar to the tables in the first two problems and compute the elasticity between the points defined by the given price plus or minus one dollar.)

Using the same demand curve, Q = 200 -4P

• How much is demanded at a price of 40 dollars? at a price of 39 dollars? at a price of 41 dollars?
• What is the coefficient of elasticity at a price of 40 dollars?
• How does this compare with the coefficient of elasticity found in the previous problem? Is elasticity the same anywhere along a straight line demand curve? How does it vary with price?

Given the demand curve Q = 100 - 1/2 P

• Can we say it is less elastic than the previous demand curve?
• Is it less elastic than the previous demand curve at a price of 30 dollars?
• Is it less elastic than the previous demand curve at a price of one dollar?
• Does elasticity vary along this demand curve? Explain how -- does elasticity increase or decrease with price? Is this the same as the previous curve?

Individual Demand Questions with Answers

1. Patty buys only two brands of golf balls: “Jack Nickless” and “Olin 1.” The more of any one she buys, the

lower the marginal utility of that ball. In spending all her income, her marginal utility of a “Nickless” is 5

and her marginal utility of an “Olin 1” is 10. The price of a “Nickless” ball is $2 and the price of an “Olin 1”

is $3. Given this information, which of the statements is true?

1. In equilibrium, patty must give up three “Olin 1” balls for two “Nickless” balls.

2. Patty would be willing to give up two “Olin 1”: balls for one “Nickless” ball.

3. Patty could increase her satisfaction by trading “Nickless” for “Olin 1.”

a. 1 only.

b. 2 only.

c. 3 only.

d. 1 and 2 only.

e. 1 and 3 only.

2 Bo Dacious buys 10 classical albums and 15 tubes of suntan lotion along with quantities of other goods.

Suppose that the price of records rises by 90 cents per album and the price of suntan lotion falls by 60 cents

per tube. Other prices and Bo’s income remain unchanged. What will Bo do?

a. Buy more albums and less suntan lotion.

b. Buy fewer albums and more suntan lotion.

c. Buy the same number of albums and more suntan lotion.

d. Remain where she is since her present position is the best attainable one after prices change.

3. Suppose an individual spends all his income on only two goods, good X and good Y. Moreover, suppose

that you were asked to derive his price consumption curve for good Y. Which of the following would be

allowed to vary?

a. Money income.

b. The tastes of the consumer.

c. The price of good X.

d. The price good Y.

4. The “compensated” demand curve is the demand curve that

a. shows only the income effect.

b. shows only the substitution effect.

c. shows both the income and substitution effects.

d. shows the Giffen good demand curve.

e. none of the above.

5. The substitution effect refers to

a. the change in quantity demanded when the price of a substitute changes.

b. the change in quantity demanded resulting from a change in total satisfaction, holding relative prices

constant.

c. the change in quantity demanded resulting from a change in relative prices, holding the level of

satisfaction constant.

d. the percentage change in quantity demanded resulting from a one percent change in all prices.

e. a movement from one indifference curve to another.

6. The income effect of a price change

a. is always positive.

b. is always negative.

c. may be positive or negative.

d. is associated with a change in nominal income.

e. is caused by changes in consumer tastes.

7. If a good is normal, then the demand curve for that good must be

a. downward sloping.

b. upward sloping.

c. perfectly elastic.

d. completely inelastic.

e. either (a) or (b); whether it is one or the other depends on the relative magnitudes of the income and Substitution effects.

8. If the demand curve for a good is downward sloping, then the good must be

a. normal.

b. inferior.

c. Giffen.

d. either (a) or (b).

e. either (b) or (c).

9. If the demand curve for a good is upward sloping, then which of the following statements must be true?

1. The good is inferior.

2. The substitution effect is in the opposite direction to the income effect.

3. The substitution effect overwhelms the income effect.

a. 1 only.

b. 2 only.

c. 1 and 2 only.

d. 2 and 3 only.

e. 1, 2, and 3.

10. When a good is an inferior good, the “non-compensated” demand curve will be

a. relatively more elastic than the compensated demand curve.

b. relatively more inelastic than the compensated demand curve.

c. equally elastic but with a different intercept than the compensated demand curve.

d. parallel to the compensated demand curve and to the right.

e. either more elastic or more inelastic depending upon the size of the income effect.

11. A normal good can be defined as one which consumers purchase more of as

a. prices fall.

b. prices rise.

c. incomes fall.

d. incomes increase.

e. the prices of other products increase.

12. An inferior good

a. can be a Giffen good, but a Giffen good is not always inferior.

b. must be a Giffen good.

c. can be a Giffen good but a Giffen good must always be an inferior good.

d. has a positively sloped demand curve.

e. all of the above.

13. Which is true of a price-consumption curve for good X?

a. Nominal income falls as the price of X falls.

b. The absolute price of X falls, but the relative price between X and the composite good Y stays the same.

c. It is always downward sloping for a normal good.

d. It represents only those market baskets that are optimal for the given price ratio and preference pattern,

and therefore a demand curve can be plotted from it.

14. The substitution effect of a price decrease for a good with a normal indifference curve pattern

a. is always inversely related to the price change.

b. measures the change in consumption of the good that is due to the consumer’s feeling of being richer.

c. is measured by the horizontal distance between the original and the new indifference curves.

d. Is sufficient information to plot an ordinary demand curve for the commodity being considered.

15. The income effect

a. always makes a consumer buy more of a good with a lowered price, all else being equal (because

lowered price implies higher real income).

b. always makes a consumer buy less of a good with an increased price, all else being equal (because

increased price implies lower real income).

c. is correctly describe by (a) and (b).

d. is correctly described by neither (a) nor (b).

16. When the substitution effect of a lowered price is counteracted by the income effect, the good in question is

a. an inferior good.

b. a substitute good.

c. an independent good.

d. a normal good.

ECON 3070 Intermediate Microeconomic Theory: Practice Multiple-Choice Questions 9

19. A price decrease and an increase in income are similar in that

a. both force the consumer to achieve a lower level of well-being.

b. both force the consumer to reach a lower indifference curve.

c. both move the budget line outward.

d. They are not similar at all.

20. The difference between a price decrease and an increase in income is that

a. a price decrease does not affect the consumption of other goods while an increase in income does.

b. an increase in income does not affect the slope of the budget line while a decrease in price does change

the slope.

c. a price decrease decreases real income while an increase in income increases real income.

d. a price decrease leaves real income unchanged while an increase in income increases real income.

21. A market demand curve can be derived by adding all the individual demand curves

a. vertically.

b. horizontally.

c. in parallel.

d. Any of the above as long as it is consistent.

22. Some goods are not closely related to each other and are neither substitutes nor complements. For such

goods, the cross-price elasticity of demand would be

a. positive.

b. negative.

c. zero.

d. Cannot tell without more information.

23. The phenomenon of the backward-bending market supply curve for labor

a. reflects the policy of labor unions.

b. reflects the scarcity of high-priced, highly skilled labor.

c. results from workers’ preference for leisure over work.

d. results from the effect of the decrease in the cost of leisure as wage rates rise.

e. indicates an increasing desire for leisure as income rises.

24. If leisure is an inferior good, the individual’s supply curve for labor is

a. backward bending.

b. completely inelastic.

c. upward sloping.

d. perfectly elastic.

e. not necessarily any of the above.

25. If the income effect resulting from a change in the price of leisure is zero, the individual’s supply curve of

labor is

a. backward bending.

b. completely inelastic.

c. upward sloping.

d. perfectly elastic.

e. not necessarily any of the above.

26. If the individual receives $5 per hour and is in equilibrium at point E, his or her income at this equilibrium

point must be

a. $40.

b. $55.

c. $65.

d. $80.

a. indeterminate.

27. In moving from point E to point G, one would conclude that

a. leisure is normal and the supply curve is upward sloping.

b. leisure is inferior and the supply curve is backward bending.

c. leisure is neither normal nor inferior and the supply curve is backward bending.

d. leisure is inferior and the supply curve is completely inelastic.

e. leisure is neither normal nor inferior and the supply curve is completely inelastic.

Individual Demand – Answers

1. c 2. b 3. d 4. b 5. c 6. c 7. a 8. d 9. c 10. b

11. d 12. c 13. d 14. a 15. d 16. a 17. a 18. a 19. c 20. b

21. b 22. c 23. e 24. c 25. c 26. a 27. e

Elasticity Concepts Questions with Answers

1. In 1991, the price of gasoline fell significantly. At the new lower price, gasoline is

a. relatively more price elastic.

b. relatively more price inelastic.

c. unaffected in terms of elasticity.

d. unitarily elastic.

e. none of the above.

2. Price elasticity of demand is defined to be

a. the change in quantity demanded resulting from a 1 cent change in price.

b. the percentage change in price resulting from a 1 unit change in quantity demanded.

c. the percentage change in quantity demanded resulting from a 1 percent change in price.

d. the maximum amount consumers will pay for 1 percent more of a good.

e. the change in the price of a good divided by the resulting change in its quantity demanded.

3. Suppose that the price elasticity of demand for maple syrup has been estimated at -2. If quantity demanded

increased by 10 percent, price must have changed by

a. 5 percent lower.

b. 5 percent higher.

c. 10 percent lower.

d. 10 percent higher.

e. cannot be determined from the given information.

4. Along any straight-line, negatively sloped demand curve,

a. the price elasticity and slope vary.

b. the price elasticity varies, but the slope remains the same.

c. the slope varies, but the price elasticity remains the same.

d. the price elasticity and slope remain the same.

e. none of the above are necessarily true.

5. Price elasticity at a given price is not affected by

a. the price of complements.

b. the price of substitutes.

c. the consumer’s income.

d. a change in tastes.

e. a change in supply.

6. The arc elasticity formula is used to estimate elasticity when

a. the product is thought to be inelastic.

b. the product is thought to be elastic.

c. the demand function is known.

d. there are two observations of price and quantity.

e. none of the above.

7. At your favorite watering spot, happy hour prices are less than normal prices for all drinks except wine. No

discount prices are offered for wine. You can conclude that

a. wine drinkers may be price elastic.

b. wine is a substitute and thus sales will rise without a price reduction.

c. wine drinkers may be price inelastic.

d. none of the above could be correct.

8. The price elasticity of demand is the same thing as the negative of the

a. slope.

b. reciprocal of slope.

c. the first derivative of the demand function.

d. reciprocal of slope times the ratio of price to quantity.

e. all of the above.

9. An elasticity coefficient of -1 means that

a. the demand curve is perfectly inelastic.

b. the demand curve is perfectly elastic.

c. the relative changes in price and quantity are equal.

d. expenditures on the good would increase if prices were reduced.

e. expenditures on the good would decrease if prices were reduced.

10. If the demand curve for a good is downward sloping, then the good must be

a. normal.

b. inferior.

c. Giffen.

d. either (a) or (b).

e. either (b) or (c).

11. Three points on a demand curve can be derived from the price consumption curve drawn perpendicular to

the X-axis, as shown in the adjoining graph. From this graph, we can see that

a. the demand for X is unit elastic.

b. the demand for Y is unit elastic.

c. the demand for X is infinitely elastic.

d. the demand for Y is infinitely elastic.

e. the demand for X is completely inelastic.

12. Three points on a demand curve can be derived from the price consumption curve drawn parallel to the Xaxis,

as shown in the adjoining graph. From this graph, we can see that

a. the demand for Y is unit elastic.

b. the demand for X is unit elastic.

c. the demand for Y is infinitely elastic.

d. the demand for X is infinitely elastic.

e. the demand for Y is completely inelastic.

13. If the demand for gasoline is relatively but not completely price inelastic, then it follows that

a. people would be willing to pay any price to drive.

b. a decrease in the price of gasoline would increase the supply of gasoline.

c. a decrease in the price of gasoline would reduce the total amount spent on gasoline.

d. gasoline consumption could not be cut without rationing.

e. an increase in the price of gasoline would not cause the quantity demanded of gasoline to fall.

14. The most important determinant of price elasticity is

a. the slope of the demand curve.

b. the availability of substitutes.

c. the price of other goods.

d. the income of the consumer.

e. the price of complements.

15. If consumers spend $15 million a month on CDs, regardless of whether the price they pay goes up or down,

that implies that their price elasticity of demand for CDs is

a. 0.

b. 1.

c. infinite.

d. 15.

e. cannot be determined.

16. Which of the following will not be a determinant of the price elasticity of demand for a commodity?

a. The absence of substitute for the good.

b. The presence of substitutes for the good.

c. The importance of the commodity in consumers’’ budgets.

d. The length of time period to which the demand curve pertains.

e. The cost of producing the commodity.

17. In 1976, a frost in Brazil killed over 500 million coffee trees and damaged many more. A civil war in

Angola, a major supplier of coffee, cut back its crop. And, an earthquake in Guatemala disrupted the flow

of coffee. In spite of these calamities, these three producers reported an increase in export earnings. On the

basis of this information, which of the following must be true?

a. The demand for coffee is price elastic.

b. The supply of coffee is price elastic.

c. The demand for coffee is price inelastic.

d. The supply of coffee is price inelastic.

e. The demand for coffee is unit elastic.

18. If the demand for emeralds is elastic, then

a. emeralds will have a high price.

b. a reduction in price will lead to an increase in the expenditure on emeralds.

c. the slope of the demand curve for emeralds must be greater than one.

d. a price reduction will not appreciably affect sales.

e. the slope of the price consumption curve for emeralds must be greater than one.

19. The market demand for a product is found by

a. horizontally summing the individual demand curves.

b. vertically summing the individual demand curves.

c. both horizontally and vertically summing the individual demand curves.

d. none of the above.

20. The price elasticity of demand will increase with the length of the period to which the demand curve

pertains because

a. consumers’ incomes will increase.

b. the demand curve will shift outward.

c. all prices will increase over time.

d. consumers will be better able to find substitutes.

e. firms will be better able to produce the good for less.

21. If the income elasticity of demand is +4

a. the good is an inferior good.

b. the good is an inelastic normal good.

c. the good is an elastic normal good.

d. the good is an elastic inferior good.

e. none of the above.

22. Luxuries are distinguished from necessities by

a. the number of substitutes available for each.

b. the fact that luxuries have high prices and necessities have low ones.

c. the high price elasticity of demand for luxuries and the low price elasticity of demand for necessities.

d. the high income elasticity of demand for luxuries and the low income elasticity of demand for

necessities.

e. the absolute slope of the Engel curve.

23. Which of the following is likely to have a negative cross price elasticity of demand?

a. Aluminum foil and cellophane.

b. Jelly beans and licorice sticks.

c. Bethlehem steel and imported Japanese steel.

d. Big Macs and French fries.

e. Buggy whips and bug spray.

25. In the early 1940s, Columbia Records, after considerable study, decided to reduce the price of classical

records with the result that total expenditure on classical records rose greatly. This would imply that at the

time.

a. the demand for classical records was greater than that for popular records.

b. the demand for classical records was highly inelastic.

c. the demand for classical records was highly elastic.

d. the demand curve for classical records was upward sloping.

e. the supply of classical records was very inelastic.

26. The income elasticity of an inferior good is

a. negative because as people get richer they increase their purchases of the good by smaller and smaller

amounts.

b. 1 because the increased income offsets the desire to consume less of the good because it is inferior.

c. greater than 1 because the richer you get, the less you consume of the good.

d. negative because higher income leads to a reduction in the amount consumed of the product.

27. The income elasticity of demand

a. is negative for normal goods.

b. is positive for inferior goods.

c. equals the relative change in demand for a good divided by the relative change in the income of

consumers, all else being equal.

d. is correctly described by all of the above.

28. If a good’s income-elasticity-of-demand estimate equaled

a. 2.46, an economist would call the good a necessity.

b. 0.37, an economist would call the good a luxury.

c. -0.50, an economist would call the good an inferior one.

d. -0.50, an economist would call the good a complementary one.

29. With Y on the vertical axis and X on the horizontal axis, if the price-consumption curve for X is upward

sloping to the right,

a. the price elasticity of demand for X is relatively elastic.

b. the price elasticity of demand for X is relatively inelastic.

c. X is an inferior good.

d. the price elasticity of demand for X is equal to -1.

30. With Y on the vertical axis and X on the horizontal axis, if the price-consumption curve for X is downward

sloping to the right,

a. the price elasticity of demand for X is relatively elastic.

b. the price elasticity of demand for X is relatively inelastic.

c. X is an inferior good.

d. the price elasticity of demand for X is equal to -1.

Elasticity Concepts – Answers

1. b 2. c 3. a 4. b 5. e 6. d 7. c 8. d 9. c 10. d

11. b 12. e 13. c 14. b 15. b 16. e 17. c 18. b 19. a 20. d

21. c 22. d 23. d 24. a 25. c 26. d 27. c 28. c 29. b 30. a

Supply, Demand, and Market Price

5. A supply curve for a good shows the

a. maximum quantities sellers are willing to offer for sale at alternative prices.

b. maximum quantities that can be produced at alternative prices.

c. quantities sellers will offer as their production costs change.

d. quantities sellers can legally supply.

6. If both supply and demand for a good increase at the same time, which of the following must also increase?

a. the equilibrium price

b. the use of substitutes

c. the equilibrium quantity

d. all of the above

7. “If at the initial price there is excess demand, the price will rise. The increase in price has two consequences:

It shifts the demand curve down since people buy less at a higher price; and it shifts the supply curve up

because producers find it profitable to produce more output at a higher price. Price will continue to adjust

until there is no excess demand.”

Which of the following is true about this statement?

a. The quotation is correct.

b. The quotation confuses excess supply with excess demand.

c. The quotation confuses movements along curves with shifts in curves.

d. The quotation confuses short-run adjustments with long-run adjustments.

8. Suppose a vaccine for the common cold is discovered. Although the government begins producing the

vaccine in as large a volume as possible, there is not enough vaccine available to meet demand.

Consequently, the government must also set up an allocation scheme to control the vaccine’s distribution.

Which of the following is true about the price of the vaccine?

a. It was above equilibrium.

b. It was below equilibrium.

c. It was at equilibrium.

d. Nothing can be determined from the information given.

.

Supply, Demand, and Market Price – Answer

1. c 2. b 3. d 4. a 5. a 6. c 7. c 8. b 9. e 10. b