Supply and Demand Practice Test Notes

Key Concepts on Supply and Demand

• Increase in Quantity Supplied:

  • Represented by a rightward shift in the supply curve.
  • Can result from:
  • Technological improvements.
  • Decrease in the price of key resources.
  • Important Note: Changes in quantity supplied are caused by price changes only, which leads to movements along the curve. Other factors shift the curves (non-price determinants).

• Inelastic Demand:

  • More inelastic when:
  • There is a lot of time to make a purchase choice (not necessarily).
  • The product is a luxury good (not true; luxury goods are often elastic).
  • Product occupies a large portion of the budget (true; makes demand more elastic).
  • Availability of substitutes (makes demand more elastic).
  • The product is a necessity (true; necessities tend to have inelastic demand).

• Trade Advantages:

  • Based on Comparative Advantage rather than absolute advantage or equal distribution of benefits.

• Opportunity Cost:

  • Related to producing additional units of goods:
  • Defined as the amount of the second good that cannot be produced due to resource allocation towards the first good.

• Rent Controls:

  • Unintended consequences may lead to decreased supply of apartments while demand increases.

• Ceteris Paribus:

  • All else equal assumption which suggests that only the price variable should be considered when assessing demand changes.

• Market Equilibrium:

  • If quantity supplied is less than quantity demanded at market price:
  • Prices tend to rise towards equilibrium.

• Classical Economic Views:

  • Adam Smith valued private property rights, competitive markets, laissez-faire policies but opposed price ceilings or floors.

• Elasticity:

  • Price elasticity of demand:
  • When % change in quantity demanded exceeds % change in price, demand is elastic.
  • When they are equal, demand is unit elastic.
  • When the price changes result in smaller % changes in quantity demanded, demand is inelastic.

• Utility Maximization:

  • If $rac{MUx}{Px} > rac{MUy}{Py}$, increase consumption of good X to maximize satisfaction.

• Comparative Advantage:

  • Should focus on the trading partner where opportunity costs for a product are the lowest.

• Price Controls:

  • Price ceilings below equilibrium lead to chronic shortages.
  • Price floors above equilibrium can cause surpluses.

• Externalities:

  • Negative externalities usually result in overproduction which can lead to government intervention through taxes or regulations.

• Resource Market Dynamics:

  • Labor and capital can be substitutes/complements affecting profit-maximizing decisions.

• Demand Change Factors:

  • Income changes, price of related goods, and consumer tastes directly affect demand.

• Market Reactions Below Equilibrium:

  • If prices fall too low, it leads to surplus (Qs > Qd).

• Supply Decrease Causes:

  • Usually due to higher resource costs, not efficiency improvements.

• PPC and Trade Benefits:

  • Trade based on comparative advantages yields measurable benefits in production and consumption efficiency.

• Graphing Exercises:

  • Practice drawing supply and demand curves for varied questions around equilibrium, externalities, rent controls, and elasticity.