H2 Economics: The Interaction of Demand and Supply

Flashcards based on H2 Economics lecture notes focusing on the interaction of demand and supply.

What does the law of demand state?

When the price of a good rises, its quantity demanded will fall, and vice versa, ceteris paribus.

What is the law of diminishing marginal utility?

Beyond a certain point of consumption, as more and more units of a good or service are consumed, the additional utility a consumer derives from successive units decreases.

What is the objective of an individual consumer?

To maximize utility, subject to cost, by consuming up to where Marginal Benefits equal Marginal Costs (MB = MC).

How is the market demand curve derived?

It is the horizontal summation of all the individual buyer’s demand curves for the good at each and every price.

What causes a movement along the demand curve?

A change in the own price of the good, ceteris paribus.

What causes a shift of the demand curve?

A change in factors other than the own price of the good (i.e., non-price determinants).

Give examples of non-price determinants of demand.

Tastes and preferences, level of income, price of related goods (substitutes and complements), ease of acquiring credit, government policies, population, expectations of future prices, exchange rates.

Define normal goods.

Goods for which demand rises as people's incomes rise, ceteris paribus.

Define inferior goods.

Goods for which demand falls as people’s incomes rise, ceteris paribus.

Define substitute goods.

Goods which are considered to be alternatives to each other.

Define complementary goods.

Goods that, when consumed together, give rise to a higher combined utility than if the goods were consumed individually.

Define derived demand.

The demand for goods which are not demanded for its own sake but is used to facilitate the production of another.

What does the law of supply state?

When the price of a good rises, its quantity supplied will rise; and when its price falls, the quantity supplied will fall, ceteris paribus.

What is the primary objective of producers?

To maximize profits.

How do producers achieve profit maximization?

By producing and selling up to where their Marginal Revenue (MR) equals the Marginal Cost (MC) of producing that unit of good.

How is the market supply curve derived?

It is the horizontal summation of all individual firms’ supply curves for the good.

What causes a movement along the supply curve?

A change in the own price of the good, ceteris paribus.

What causes a shift of the supply curve?

A change in factors other than the own price of the good (i.e., non-price determinants).

Give examples of non-price determinants of supply.

Change in input prices, change in technology, government policies, number and size of firms, price of related goods (joint and competitive supply), supply shocks, expectations of future prices.

Define goods in joint supply.

Goods where the production of one good leads to the production of the other good.

Define goods in competitive supply.

Goods that compete for the use of the same inputs.

What conditions define a perfectly competitive market?

A large number of buyers and sellers transacting a homogeneous product, perfect information among buyers and sellers, and negligible transaction costs.

What is market equilibrium?

The point where quantity demanded equals quantity supplied.

List the four functions of prices in a perfectly competitive market.

Signaling function, incentive function, allocative function, rationing function.

Define price mechanism.

The process by which consumers and producers interact to determine the allocation of scarce resources between competing uses.

Define shortage.

A situation which exists at any price below the equilibrium price where quantity demanded exceeds quantity supplied.

Define surplus.

A situation which exists at any price above the equilibrium price where quantity supplied exceeds quantity demanded.