Untitled Flashcards Set

Think about a competitive market in which you participate regularly. For each of the characteristics of a competitive market, explain how your market meets these requirements.  [LO 3.1]

Answer: The market for eggs is competitive. There are many grocery stores where eggs can be purchased. Standardized good: Eggs are a standardized good. There are different kinds of eggs, of course, but each unit of a particular type of egg will be standardized. Full information: The ubiquity of grocery stores makes it easy for buyers and sellers to gather information about the price of eggs. No transaction costs: There are no transaction costs or other limits to buying and selling eggs. Buyers and sellers can easily find each other. Participants are price takers: I am one consumer among many and my purchase patterns have no effect on the market price. Likewise, there are so many places to buy eggs that sellers are also price takers. 

2.   Think about a noncompetitive market in which you participate regularly. Explain which

      characteristic(s) of competitive markets your market does not meet.  [LO 3.1]

Answer: I take the subway to work every day. Public transportation is not a competitive market. There is only one subway system, so there is no competition. The subway is a natural monopoly (students will learn about monopolies in a later chapter). For now, it is enough to know that without competition, the MTA (Metropolitan Transportation Authority)—which operates the subway system—is not a price taker. The passengers are certainly price takers, but the operator is not.

3.   Explain why a demand curve slopes downward.  [LO 3.2]

Answer: The demand curve slopes downward because as prices increase, quantity demanded decreases. Price and quantity move in opposite directions and have a negative relationship for demand. Think about your incentives when the price of a good you want to purchase increases. The quantity you demand of that good is likely to move in the other direction and decrease. When price and quantity move in opposite directions, the result is a downward sloping curve.

4.   In each of the following examples, name the factor that affects demand and describe its impact on your demand for a new cell phone.  [LO 3.2]

a.     You hear a rumor that a new and improved model of the phone you want is coming out next year.

b.     Your grandparents give you $500.

c.     A cellular network announces a holiday sale on a data package that includes the purchase of a new smartphone.

d.     A friend tells you how great his new phone is and suggests that you get one, too.

Answer:

a.     Expectations. Your current demand will decrease in the present as you postpone purchasing under the expectation that a new model will be released next year.

b.     Incomes. Your purchasing power has increased due to the money given to you by your grandparents. Your demand will increase.

c.     Price of a Related Good. When the price of a data package (a complementary good) goes down due to the sale, demand for smartphones increases.

d.     Consumer Preferences. Your friend influences your interest in purchasing a phone. Your friend’s enjoyment of his phone and suggestion that you also purchase a phone increases your demand.

5.   Consider the following events:

a.     The price of cell phones goes down by 25 percent during a sale.

b.     You get a 25 percent raise at your job.

Which event represents a shift in the demand curve? Which represents a movement along the curve? What is the difference?  [LO 3.3]

Answer: The relationship between price and quantity demanded is directly reflected in the demand curve. A change in price will mean a movement along an existing curve. Factors of demand that are held constant, such as income, cause a shift in the demand curve when they change.

a.     When the price of cell phones goes down by 25 percent, this is a movement along the demand curve for cell phones. 

b.     When your income increases by 25 percent, there is a shift in the demand curve, as income is a factor of demand held constant in any given demand curve.

6.   What is the difference between a change in demand and a change in quantity demanded?  [LO 3.3]

Answer: When we refer to a change in demand, we are referring to a shift of the entire curve. This happens when a non-price factor changes—such as income, expectations, prices of related goods, consumer preferences or the number of buyers. A change in quantity demanded refers to a change in the specific numerical quantity demanded due to a change in price.

7.   Explain why a supply curve slopes upward.  [LO 3.4]

Answer: The supply curve slopes upward because as prices increase, quantity supplied also increases. Price and quantity move in the same direction and have a positive relationship for supply. Think about the incentives facing a producer when the price of the good she is producing increases. The quantity she is willing and able to supply of that good is likely to also increase. When price and quantity move in the same direction, the result is an upward sloping curve.

8.   In each of the following examples, name the factor that affects supply and describe its impact on the supply of cell phones.  [LO 3.4]

a.     Economic forecasts suggest that the demand for cell phones will increase in the future.

b.     The price of plastic goes up.

c.     A new screen technology reduces the cost of making cell phones.

Answer:

a.     Expectations. If demand for cell phones is expected to increase in the future, then the price of cell phones is expected to increase in the future. Current supply of cell phones may decrease if supplies are able to withhold inventory waiting on prices to increase. Supply of cell phones will eventually increase as prices do rise.

b.     Prices of Inputs. Plastic is an input in the production of cell phones. If the price of plastic increases, production costs increase and supply decreases.

c.     Technology. If advancement in screen technology reduces the cost of making cell phones, supply of cell phones will increase.

9.   Consider the following events:

a.     A fruit worm infestation ruins a large number of apple orchards in Washington state.

b.     Demand for apples goes down, causing the price to fall.

Which event represents a shift in the supply curve? Which represents a movement along the curve? What is the difference?  [LO 3.5]

Answer: Factors of supply that are held constant, such as number of suppliers, cause a shift in the supply curve when they change. The relationship between price and quantity supplied is directly reflected in the supply curve. A change in price will mean a movement along an existing curve.

a.     A fruit worm infestation will cause a shift in the supply of apples, as the number of orchards (sellers) able to supply to the market will decrease. 

b.     When demand decreases and prices fall, there is a movement along the supply curve.

10. What is the difference between a change in supply and a change in quantity supplied?  [LO

      3.5]

Answer: When we refer to a change in supply, we are referring to a shift of the entire curve. This happens when a non-price factor changes—such as technology, expectations, prices of related goods, prices of inputs or the number of sellers. A change in quantity supplied refers to a change in the specific numerical quantity supplied due to a change in price.

11. What is the relationship between supply and demand when a market is in equilibrium?

Explain how the incentives facing cell phone companies and consumers cause the market for cell phones to reach equilibrium.  [LO 3.6]

Answer: When a market is in equilibrium, quantity supplied equals quantity demanded. We say that supply and demand are in agreement at market equilibrium. Cell phone sellers have an incentive for prices to rise and cell phone consumers would like for prices to fall. Because their incentives are not aligned, each side will create opposing pressure on market prices. Equilibrium represents the price at which both consumers and suppliers of cell phones agree to buy/sell a given quantity.

12. Explain why the equilibrium price is often called the market-clearing price.  [LO 3.6]

Answer: The equilibrium price is often called the market clearing price because it is the price at which the market “clears” in the sense that there is neither excess demand nor excess supply. Quantity supplied equals quantity demanded at this price. Every buyer who wants to buy at this price can find supply and every supplier who wants to sell at this price can find a buyer.

13. Suppose an economic boom causes incomes to increase. Explain what will happen to the

demand and supply of phones, and predict the direction of the change in the equilibrium price and quantity.  [LO 3.7]

Answer: If incomes increase, there will be an increase in demand for cell phones. If no other shifts occurred, both the price of cell phones and the quantity of cell phones traded would rise.

14. Suppose an economic boom drives up wages for the sales representatives who work for cell

phone companies. Explain what will happen to the demand and supply of phones, and predict the direction of the change in the equilibrium price and quantity.  [LO 3.7]

Answer: If an increase in wages causes an increase in production costs for sellers of cell phones, supply of cell phones will decrease. If no other shifts had occurred, a decrease in supply would cause prices to rise and the number of cell phones traded to decrease.

15. Suppose an economic boom causes incomes to increase and at the same time drives up wages

for the sales representatives who work for cell phone companies. Explain what will happen to the demand for and supply of phones and predict the direction of the change in the equilibrium price and quantity.  [LO 3.7]

Answer: When both an increase in demand and a decrease in supply occur, we know that the price of cell phones will rise. It is unclear whether the quantity of cell phones traded will increase or decrease. It depends on whether the shift in demand is larger or smaller than the shift in supply.

Problems and Applications

1.   Consider shopping for cucumbers in a farmers’ market. For each statement below, note which characteristic of competitive markets the statement describes. Choose from:  standardized good, full information, no transaction costs, and participants are price takers.  [LO 3.1]

a.     All of the farmers have their prices posted prominently in front of their stalls.

b.     Cucumbers are the same price at each stall.

c.     There is no difficulty moving around between stalls as you shop and choosing between farmers.

d.     You and the other customers all seem indifferent about which cucumbers to buy.

Answer: A standardized good is a good for which any two units have the same features and are interchangeable. In a competitive market, you have full information about the price and features of the good being bought and sold. In competitive markets, there are no transaction costs, meaning that you don’t have to pay anything for the privilege of buying or selling in the market. In economic terminology, a buyer or seller who cannot affect the market price is called a price taker.

a.     Full information

b.     Participants are price takers

c.     No transaction costs

d.     Standardized good

2.   Suppose two artists are selling paintings for the same price in adjacent booths at an art fair. By the end of the day, one artist has nearly sold out of her paintings while the other artist has sold nothing. Which characteristic of competitive markets has not been met and best explains this outcome?  [LO 3.1]

a.     Standardized good.

b.     Full information.

c.     No transaction costs.

d.     Participants are price takers.

Answer: A standardized good is a good for which any two units have the same features and are interchangeable. In a competitive market, you have full information about the price and features of the good being bought and sold. In competitive markets, there are no transaction costs, meaning that you don’t have to pay anything for the privilege of buying or selling in the market. In economic terminology, a buyer or seller who cannot affect the market price is called a price taker. This is not a standardized good. The booths are adjacent with prices clearly posted so full information is available without transaction costs. The prices of the paintings are the same, which may indicate that the artists are price-takers. The best explanation for the difference in sales is that the paintings are not standardized. The artists may have very different styles or levels of talent.

3.   Using the demand schedule in Table 3P-1, draw the daily demand curve for slices of pizza in a college town.  [LO 3.2]

Answer:

4.   Consider the market for cars. Which determinant of demand is affected by each of the following events? Choose from: consumer preferences, prices of related goods, incomes, expectations, and the number of buyers.  [LO 3.2]

a.     Environmentalists launch a successful One Family, One Car campaign.

b.     A baby boom occurred 16 years ago.

c.     Layoffs increase as the economy sheds millions of jobs.

d.     An oil shortage causes the price of gasoline to soar.

e.     The government offers tax rebates in return for the purchase of commuter rail tickets.

f.      The government announces a massive plan to bail out the auto industry and subsidize production costs.

Answer: The non-price determinants of demand can be divided into five major categories: consumer preferences, the prices of related goods, incomes, expectations of future prices, and the number of buyers in the market.

a.     Consumer preferences

b.     Number of buyers

c.     Incomes

d.     Prices of related goods

e.     Prices of related goods

f.      Expectations

5.   If a decrease in the price of laptops causes the demand for tablets to increase, are laptops and tablets substitutes or complements?  [LO 3.2]

Answer: If a decrease in the price of laptops causes the demand for tablets to increase, laptops and tablets are complements. A decrease in the price of laptops increases the quantity demanded for laptops (a movement along the curve). If the demand for tablets also increases (a shift of the curve), consumers use laptops and tablets together.

6.   If rising incomes cause the demand for beer to decrease, is beer a normal or inferior good?  [LO 3.2]

Answer: If rising incomes cause the demand for beer to decrease, beer is an inferior good. If this is the case for beer, this could be because consumers substitute preferred drinks such as wine or liquor when their income rises.

7.   Consider the market for corn. Say whether each of the following events will cause a shift in the demand curve or a movement along the curve. If it will cause a shift, specify the direction.  [LO 3.3]

a.     A drought hits corn-growing regions, cutting the supply of corn.

b.     The government announces a new subsidy for biofuels made from corn.

c.     A global recession reduces the incomes of consumers in poor countries, who rely on corn as a staple food.

d.     A new hybrid variety of corn seed causes a 15 percent increase in the yield of corn per acre.

e.     An advertising campaign by the beef producers’ association highlights the health benefits of corn-fed beef.

Answer: A change in the price of a good will cause a movement along the demand curve. A change in a nonprice determinant will cause a shift of the demand curve.

a.     Movement along the curve: There is a decrease in supply, which causes an increase in price and a decrease in quantity demanded.

b.     Shift in the curve: There is an increase in demand (rightward shift).

c.     Shift in the curve: There is a decrease in demand (leftward shift).

d.     Movement along the curve: There is an increase in supply, which causes a decrease in price and an increase in quantity demanded.

e.     Shift in the curve: There is an increase in demand (rightward shift).

8.   The demand curve in Figure 3P-1 shows the monthly market for sweaters at a local clothing store. For each of the following events, draw the new outcome.  [LO 3.3]

a.     Sweaters fall out of fashion.

b.     There is a shortage of wool.

c.     The winter is particularly long and cold this year. 

d.     Sweater vendors offer a sale.

      Answer:

a.     Point D: This is a change in a nonprice determinant. The demand curve will shift to the left because people prefer to buy fewer sweaters.

b.     Point B: A shortage of wool will increase the price of sweaters and the supply curve will shift left, causing a movement up along the demand curve.

c.     Point E: This is a change in a nonprice determinant. The demand curve will shift to the right as people prefer to buy more sweaters.

d.     Point C: The price of sweaters decreases and the supply curve will shift right, causing a movement down along the demand curve.

9.   Using the supply schedule found in Table 3P-2, draw the daily supply curve for slices of pizza in a college town.  [LO 3.4]

Answer: The supply schedule shows the quantity of pizza slices that firms are willing and able to sell (supply) at various prices.  Each price/quantity combination from the supply schedule can be plotted on the graph to illustrate the supply curve.

10. Consider the market for cars. Which determinant of supply is affected by each of the

following events? Choose from: prices of related goods, technology, prices of inputs, expectations, and the number of sellers in the market.  [LO 3.4]

a.     A steel tariff increases the price of steel.

b.     Improvements in robotics increase efficiency and reduce costs.

c.     Factories close because of an economic downturn.

d.     The government announces a plan to offer tax rebates for the purchase of commuter rail tickets.

e.     The price of trucks falls, so factories produce more cars.

f.      The government announces that it will dramatically rewrite efficiency standards, making it much harder for automakers to produce their cars.

Answer: Several non-price factors determine the supply of a good at any given price: They include the prices of related goods, technology, prices of inputs, expectations about the future, and the number of sellers in the market.

a.     Prices of inputs

b.     Technology

c.     Number of sellers

d.     Expectations

e.     Prices of related goods

f.      Technology

11. Consider the market for corn. Say whether each of the following events will cause a shift in the supply curve or a movement along the curve. If it will cause a shift, specify the direction.  [LO 3.5]

a.     A drought hits corn-growing regions.

b.     The government announces a new subsidy for biofuels made from corn.

c.     A global recession reduces the incomes of consumers in poor countries, who rely on corn as a staple food.

d.     A new hybrid variety of corn seed causes a 15 percent increase in the yield of corn per acre.

e.     An advertising campaign by the beef producers’ association highlights the health benefits of corn-fed beef.

Answer: A change in the price of a good will cause a movement along the supply curve. A change in a non-price determinant will cause a shift of the supply curve.

a.     Shift in the curve: There is a decrease in supply (leftward shift).

b.     Movement along the curve: There is an increase in demand.

c.     Movement along the curve: There is a decrease in demand.

d.     Shift in the curve: There is an increase in supply (rightward shift).

e.     Movement along the curve: There is an increase in demand.

12. The supply curve in Figure 3P-2 shows the monthly market for sweaters at a local craft

      market. For each of the following events, draw the new outcome.  [LO 3.5]

a.     The price of wool increases.

b.     Demand for sweaters decreases.

c.     A particularly cold winter is expected to begin next month.

d.     Demand for sweaters increases.

Answer: A change in the price of a good will cause a movement along the supply curve. A change in a nonprice determinant will cause a shift of the supply curve.

a.     Point C: This is a change in a nonprice determinant. The supply curve will shift to the left because input prices have increased.

b.     Point E: A decrease in the demand for sweaters will decrease the price of sweaters, causing a movement down along the supply curve.

c.     Point B: This is a change in a nonprice determinant. The supply curve will shift to the right because firms expect the demand for sweaters to increase.

d.     Point D: An increase in the demand for sweaters will increase the price of sweaters, causing a movement up along the supply curve.

13. Refer to the demand and supply schedule shown in Table 3P-3.  [LO 3.6]

a.     If pizza parlors charge $3.50 per slice, will there be excess supply or excess demand? What is the amount of excess supply or excess demand at that price? 

b.     If pizza parlors charge $1.00 per slice, will there be excess supply or excess demand? What is the amount of excess supply or excess demand at that price?

c.     What are the equilibrium price and quantity in this market?

Answer:   

a.     When the price is above the equilibrium price there is an excess supply. In this case, there is an excess supply of 400 slices.

b.     When the price is below the equilibrium price there is an excess demand. In this case when the price is $1.00, quantity demanded is 250 slices and the quantity supplied is 150 slices, there is an excess demand of 100 slices.

c.     The equilibrium price occurs where the quantity demanded equals the quantity supplied, at $1.50. The equilibrium quantity is 200 slices.

The graph in Figure 3P-3 shows the weekly market for pizzas in a small town. Use this graph to answer Problems 14–16.

14. Which of the following events will occur at a price of $20?  [LO 3.6]

a.     Equilibrium.

b.     Excess demand.

c.     Excess supply.

d.     No pizzas supplied.

e.     No pizzas demanded.

Answer: There is an excess supply. $20 is above the equilibrium price, which will lead to an excess supply because quantity supplied is greater than quantity demanded.

15. Which of the following events will occur at a price of $10?  [LO 3.6]

a.     Equilibrium.

b.     Excess demand.

c.     Excess supply.

d.     No pizzas supplied.

e.     No pizzas demanded.

Answer: There is an excess demand. $10 is below the equilibrium price, which will lead to excess demand because quantity supplied is less than quantity demanded.

16. What are the equilibrium price and quantity of pizzas?  [LO 3.6]

Answer: Graphically the equilibrium price and quantity are found at the point where the supply curve intersects the demand curve.  At this equilibrium price, the quantity demanded by buyers is equal to the quantity supplied by the sellers and there is no incentive for the sellers to change the price of the good.  In other words, there is no excess demand or excess supply for the good.  The equilibrium price is $15, and the equilibrium quantity is 150 pizzas.

17. The graph in Figure 3P-4 shows supply and demand in the market for automobiles. For each

of the following events, draw the new market outcome, and say whether the equilibrium price and quantity will increase or decrease. 

[LO 3.7]

a.     Environmentalists launch a successful One Family, One Car campaign.

b.     A steel tariff increases the price of steel.

c.     A baby boom occurred 16 years ago.

d.     An oil shortage causes the price of gasoline to soar.

e.     Improvements in robotics increase efficiency and reduce costs.

f.      The government offers a tax rebate for the purchase of commuter rail tickets.

Answer:

a.     If more families decide to own only one car instead of two or three cars then there is a decrease in the demand for cars.  As a result, there will be an excess demand for cars at the existing price and firms will have an incentive to reduce the price of cars.  Equilibrium price and quantity will both decrease and the new equilibrium is at point A.

b.     The increase in the price of steel will increase the cost of producing cars and this will increase the price of cars.  The supply curve will shift to the left (a decrease in supply), and the new equilibrium is at point B.  The price increases and quantity decreases.

c.     As these children turn 16, they will learn to drive and some of them will buy cars.  The demand for cars will increase and the new equilibrium is at point C.  Price increases and quantity increases.

d.     An increase in the price of gas will make driving more expensive and this will decrease the demand for cars.  The new equilibrium is at point A. Price decreases and quantity decreases.

e.     If the cost of production falls, then firms are willing to sell cars for a lower price.  The supply curve will shift to the right (increase in supply) and equilibrium is at point D.  The price decreases and quantity increases.

f.      A tax rebate on rail tickets will reduce the cost of train travel (a substitute for driving) and this will decrease the demand for cars.  The new equilibrium is at point A. The price decreases and quantity decreases.

18. Say whether each of the following changes will increase or decrease the equilibrium price

and quantity, or whether the effect cannot be predicted. [LO 3.7]

a.     Demand increases; supply remains constant.

b.     Supply increases; demand remains constant.

c.     Demand decreases; supply remains constant.

d.     Supply decreases; demand remains constant.

e.     Demand increases; supply increases.

f.      Demand decreases; supply decreases.

g.     Demand increases; supply decreases.

h.     Demand decreases; supply increases.

Answer: In the first four parts, only one curve is shifting, so the impact on equilibrium price and quantity can be predicted. In the last four parts, two changes are occurring at the same time, so the impact on either equilibrium price or quantity cannot be predicted. Consider a simultaneous increase in demand and increase in supply. The increase in demand will increase equilibrium price and quantity. The increase in supply will decrease equilibrium price and increase equilibrium quantity. Both changes lead to an increase in equilibrium quantity, so this can be predicted. The two changes have opposite impacts on equilibrium price, so this cannot be predicted.

a.     The equilibrium price increases, and the equilibrium quantity increases.

b.     The equilibrium price decreases, and the equilibrium quantity increases.

c.     The equilibrium price decreases, and the equilibrium quantity decreases.

d.     The equilibrium price increases, and the equilibrium quantity decreases.

e.     The equilibrium price cannot be predicted, and the equilibrium quantity increases.

f.      The equilibrium price cannot be predicted, and the equilibrium quantity decreases.

g.     The equilibrium price increases, and the equilibrium quantity cannot be predicted.

h.     The equilibrium price decreases, and the equilibrium quantity cannot be predicted.