Economics Chapter 3: Demand and Supply

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Questions and Answers

What is a market?

Any arrangement that enables buyers and sellers to get information and do business with each other.

In a competitive market, a single buyer or seller can influence the price.

False

What does the Law of Demand state?

The higher the price of a good, the smaller the quantity demanded, and the lower the price, the larger the quantity demanded.

What are the two effects that explain why a change in price affects quantity demanded?

Income effect Signup and view all the answers

What happens to the quantity demanded when the price of a good rises?

The quantity demanded decreases. Signup and view all the answers

What are the six main factors that can change demand?

Prices of related goods, expected future prices, income, expected future income and credit, population, preferences. Signup and view all the answers

What is the difference between a normal good and an inferior good?

A normal good's demand increases as income increases, whereas an inferior good's demand decreases as income increases. Signup and view all the answers

Match the concepts with their definitions:

Substitute = A good that can be used in place of another good Complement = A good that is used in conjunction with another good Normal good = Demand increases as income increases Inferior good = Demand decreases as income increases Signup and view all the answers

What is an opportunity cost?

The ratio of a good's price to that of the next best alternative Signup and view all the answers

What is the production possibilities frontier (PPF)?

The boundary between combinations of goods and services that can be produced and those that cannot. Signup and view all the answers

What does it mean when a point is inside the PPF?

It is inefficient. Signup and view all the answers

All points on the PPF are efficient.

True Signup and view all the answers

What is opportunity cost?

The quantity of a good forgone to produce more of another good. Signup and view all the answers

How does increasing production of one good affect the other good along the PPF?

It involves a trade-off. Signup and view all the answers

What happens to opportunity cost as production increases for each good?

It increases. Signup and view all the answers

What is the marginal cost of a pizza?

The opportunity cost of producing one more pizza. Signup and view all the answers

Study Notes

Markets and Prices

A market facilitates transactions between buyers and sellers and provides information.
A competitive market contains numerous buyers and sellers, preventing any single entity from influencing prices.
The money price of a good is the monetary cost required to purchase it.
Relative price measures opportunity cost, calculated as the money price of a good compared to the next best alternative.

Demand

Demand reflects consumer behavior, including the desire for a product, affordability, and a definitive purchasing plan.
Quantity demanded indicates the amount consumers intend to purchase at a specified price in a given time period.

Law of Demand

Higher prices lead to lower quantities demanded, while lower prices increase quantities demanded (ceteris paribus).
Changes in price affect quantity demanded due to two phenomena:
- Substitution Effect: Consumers shift to substitutes when a good’s relative price rises.
- Income Effect: A price rise diminishes the purchasing power, decreasing quantity demanded.

Demand Curve and Schedule

Demand illustrates the connection between a product's price and the quantity demanded.
A demand curve visually represents this relationship, assuming other factors remain constant.
Movements along the demand curve occur with price changes: rising prices reduce quantity demanded and moving up the curve, while falling prices increase quantity demanded and move down the curve.

Willingness and Ability to Pay

The demand curve also functions as a willingness-and-ability-to-pay curve; as quantity decreases, the price consumers are willing to pay for additional units increases.
Willingness to pay correlates with the marginal benefits consumers expect.

Change in Demand

A shift in demand occurs when factors other than price influence buying plans, leading to a new demand curve.
An increase in demand shifts the curve to the right, while a decrease shifts it to the left.

Factors Influencing Demand

Six primary factors that can alter demand:
- Prices of related goods (substitutes and complements)
- Expected future prices
- Income levels
- Future income expectations and access to credit
- Population changes
- Consumer preferences

Substitutes: Goods that can replace one another; an increase in the price of a substitute raises demand for the original good.
Complements: Goods used together; a decrease in the price of a complement increases demand for the related good.

Expected Future Prices

Anticipated price increases for goods lead to a current rise in demand, resulting in a rightward shift of the demand curve.

Income Effects

An increase in consumer income generally leads to an increase in demand for most goods, shifting the demand curve rightward.
Normal Goods: Demand rises with higher income.
Inferior Goods: Demand decreases as income increases.

Production Possibilities Frontier (PPF)

The PPF illustrates the maximum combinations of two goods that can be produced given fixed resources, highlighting production capacity limits.
Points on the PPF indicate efficient production levels, while points inside suggest inefficiency, with potential for increased output without sacrificing other goods.

Opportunity Cost

Opportunity cost reflects what is sacrificed when choosing one option over another; moving along the PPF involves tradeoffs between two goods.
Example: Increasing pizza production by one million results in a decrease of five million cola cans, indicating that producing 1 million pizzas costs 5 million cans of cola.

Increasing Opportunity Cost

The PPF appears bowed outward because resources are not uniformly productive across all goods.
As output of a good increases, its opportunity cost also rises, which signifies higher trade-offs for additional production.

Production Efficiency

Production efficiency is achieved when resources are fully utilized and not producing more of one good without reducing the output of another.
Points along the PPF demonstrate efficient allocation, while those inside indicate resource misallocation or unemployment.

Marginal Cost and Benefits

Marginal cost represents the opportunity cost of producing an additional unit of a good and increases along the PPF.
Understanding marginal benefits is critical for assessing resource allocation; efficient decisions balance marginal costs with marginal benefits.

Specialization and Trade

Specialization enhances resource use efficiency, allowing economies to focus on producing goods where they have a comparative advantage.
Trade facilitates access to a wider variety of goods and services, improving overall economic efficiency through resource reallocation.

Economic Institutions

Institutions such as markets, governments, and laws coordinate economic decisions and resource allocation, impacting how production and trade occur.

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Description

This quiz covers key concepts from Chapter 3 on Demand and Supply. You will explore the characteristics of a competitive market, the influences on demand and supply, and how these factors determine market prices and quantities. Prepare to apply the demand and supply model to real-world scenarios and predictions.