| Chapter 3 Outline | ||
| II. THE EFFECTS OF CHANGES IN DEMAND AND SUPPLY ON EQUILIBRIUM PRICE AND QUANTITY | ||
| A. Change in Demand | ||
| 1. A change in demand will cause equilibrium price and output to change in thesame direction. | ||
| a. A decrease in demand will cause a reduction in the equilibrium price and quantity of a good. | ||
| 1. The decrease in demand causes excess supply to develop at the initial price. | ||
| a. Excess supply will cause price to fall, and as price falls producers are willing to supply less of the good, thereby decreasing output. | ||
| b. An increase in demand will cause an increase in the equilibrium price and quantity of a good. | ||
| 1. The increase in demand causes excess demand to develop at the initial price. | ||
| a. Excess demand will cause the price to rise, and as price rises producers are willing to sell more, thereby increasing output. | ||
| B. Change in Supply | ||
| 1. A change in supply will cause equilibrium price and output to change inopposite directions. | ||
| a. An increase in supply will cause a reduction in the equilibrium price and an inase in the equilibrium quantity of a good. | ||
| 1. The increase in supply creates an excess supply at the initial price. | ||
| a. Excess supply causes the price to fall and quantity demanded to increase. | ||
| b. An dcrease in supply will cause an increase in the equilibrium price and a decrease in the equilibrium quantity of a good. | ||
| 1. The decrease in supply creates an excess demand at the initial price. | ||
| a. Excess demand causes the price to rise and quantity demanded to decrease. | ||
| C. Changes in Demand and Supply | ||
| 1. If demand and supply change in opposite directions, then the change in theequilibrium price can be determined, but the change in the equilibrium. output cannot. | ||
| a. A decrease in demand and an increase in supply will cause a fall in equilibrium price, but the effect on equilibrium quantity cannot be determined. | ||
| 1. For any quantity, consumers now place a lower value on the good, and producers are willing to accept a lower price; therefore, price will fall. The effect on output will depend on the relative size of the two changes. | ||
| b. An increase in demand and a decrease in supply will cause an increase in equilibrium price, but the effect on equilibrium quantity cannot be detennined. | ||
| 1. For any quantity, consumers now place a higher value on the good,and producers must have a higher price in order to supply the good; therefore, price will increase. The effect on output will depend on the relative size of the two changes. | ||
| 2. If demand and supply change in the same direction, the change in the equilibrium output can be determined, but the change in the equilibrium price cannot. | ||
| a. If both demand and supply increase, there will be an increase in the equilibrium output, but the effect on price cannot be determined. | ||
| 1. If both demand and supply increase, consumers wish to buy more and firms wish to supply more so output will increase. However, since consumers place a higher value on each unit, but producers are willing to supply each unit at a lower price, the effect on price will depend on the relative size of the two changes. | ||
| b. If both demand and supply decrease, there will be a decrease in the equilibrium output, but the effect on price cannot be determined. | ||
| 1. If both demand and supply decrease, consumers wish to buy less andfirms wish to supply less, so output will fall. However, since consumers place a lower value on each unit, but producers are willing to supply each unit only at higher prices, the effect on price will depend on the relative size of the two changes. |
a. What is the equilibrium price of hot dogs? What makes you think so?
According to the definition, the equilibrium price is the price at which quantity supplied equals quantity demanded. From the table we can see that at $1.60, Qs = Qd = 2,400. Therefore $1.60 is the equilibrium price.
b. If the organizers of the sporting event decide to set the price at 1.80, how many hot dogs will be sold?
At $1.80, 4,800 hot dogs will be offered for sale, but only 1,600
will be demanded. Therefore, only 1,600 hot dogs will be sold.
2. True or False? Explain.
In economics, "normal good" is the name for a good a normal individual can afford.
False. The expression "normal good" means that when a person's income increases, the consumption of that good also increases.
3. a. State the Law of Demand.
As the price of a good rises, all other things being equal, the quantity demanded of that good falls.
b. Over the last two decades, tuition fees at Purdue University have increased by 50%. At the same time, the number of students enrolled has increased from 22,000 to over 35,000.
Does this example demonstrate that the Law of Demand is false? Explain why or why not. Use graphs.
No, this fact does not refute the Law of Demand. The Law of Demand tells us what will happen to quantity demanded if price is the only factor that changes. In the
example provided, many things have probably changed over twenty years, average family income and the reputation of the school being just two of them. As a result, the demand for the services provided by that university has shifted. See graph.
4. The total demand for wheat and the total supply of wheat per month in the Kansas City grain market are as follows:
Thousands of bushels | Price per bushel, $ | Thousands of bushels supplied | Surplus (+) |
85 | 3.40 | 72 | - 13 |
80 | 3.70 | 73 | - 7 |
75 | 4.00 | 75 | 0 |
70 | 4.30 | 77 | + 7 |
65 | 4.60 | 79 | + 14 |
60 | 4.90 | 81 | + 21 |
a. Market equilibrium occurs at the point where market clears, that is, where quantity supplied is equal to quantity demanded. In other words, equilibrium price is the price at which there exists neither surplus nor shortage. Looking at the entries in the last column (in bold), we can see the equilibrium price is $4. Therefore, the equilibrium quantity is 75,000 bushels.
b. For your individual work.
c. At $3.40, there would be a 13,000 bushels
shortage of wheat. The price will not stay at that level since it will be in the sellers' best interest to raise their prices.
At $4.90, sellers will supply 21,000 bushels more than buyers would demand, thus creating a surplus. In order to get rid of the surplus, sellers would have to decrease their price.
d. The statement is false. A surplus means that at a given price, quantity supplied is greater than quantity demanded. Trying to get rid of the surplus, sellers will decrease their prices. Therefore, surpluses drive prices down, not up. Shortages, on the other hand, give sellers the opportunity to raise prices, hence "shortages drive prices up".
e. A ceiling at $3.70 established by the government (which probably tries to prevent the price from being what it perceives as "too high") would not allow the price to move towards the equilibrium. As a result, a permanent shortage of wheat will emerge. Buyers will demand 7000 more bushels of wheat than
there is available.