Microeconomics Chapter 2: Supply and Demand
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Questions and Answers

What is the primary purpose of the Retail Price Index (RPI)?

  • To analyze demand and supply
  • To forecast GDP
  • To track inflation (correct)
  • To measure economic growth

    • The RPI is presented on a quarterly basis to minimize data collection costs.

    False

    What is the main difference between monetarist and Keynesian theories of inflation?

    Monetarist theory blames inflation on excess money supply, while Keynesian theory blames it on aggregate demand.

    A supply-side shock, such as an increase in _______________, can lead to cost-push inflation.

    <p>wages</p> Signup and view all the answers

    Match the following types of inflation with their definitions:

    <p>Demand-pull = Inflation caused by an increase in aggregate demand Cost-push = Inflation caused by a decrease in production costs Imported = Inflation caused by an increase in prices of imported goods</p> Signup and view all the answers

    Which of the following is a practical use of the RPI for a Central Banker?

    <p>To set monetary policy</p> Signup and view all the answers

    Inflation can be completely defeated.

    <p>False</p> Signup and view all the answers

    What is the main effect of inflation on the economy?

    <p>Inflation reduces the purchasing power of consumers and can lead to uncertainty and instability in the economy</p> Signup and view all the answers

    Who would find it useful to have an estimate of price elasticity of demand for the products their members produce?

    <p>Trade unions</p> Signup and view all the answers

    Demand for workers is directly related to the price elasticity of demand for the product they produce.

    <p>True</p> Signup and view all the answers

    What happens to the price elasticity of demand as we move up a linear demand curve?

    <p>It rises.</p> Signup and view all the answers

    If the income elasticity of demand is negative, the product is considered a __________ good.

    <p>inferior</p> Signup and view all the answers

    What is the numerical value measuring the degree of consumers' responsiveness to a given change in income, ceteris paribus?

    <p>Income elasticity of demand</p> Signup and view all the answers

    An Engel curve shows the amount of a good demanded at different levels of price.

    <p>False</p> Signup and view all the answers

    What is the range of income elasticity of demand for a necessity?

    <p>Positive and less than 1</p> Signup and view all the answers

    Match the following income elasticity of demand values with the corresponding type of good:

    <p>Negative = Inferior good Positive and less than 1 = Necessity Positive and greater than 1 = Superior or luxury good</p> Signup and view all the answers

    What happens to the supply of one good when the price of another jointly supplied good increases, ceteris paribus?

    <p>The supply of the first good increases</p> Signup and view all the answers

    An increase in government subsidies on a firm will lead to a decrease in the supply of the good.

    <p>False</p> Signup and view all the answers

    What is the effect of a rise in the price of one good on the supply of another jointly supplied good?

    <p>An increase in the supply of the other good</p> Signup and view all the answers

    The producers' surplus is the difference between the minimum price a producer would accept to supply a given quantity of a good and the price actually _______________.

    <p>received</p> Signup and view all the answers

    What is the effect of an increase in the number of firms in an industry on the industry's supply curve?

    <p>The supply curve shifts outward</p> Signup and view all the answers

    An improvement in technology will lead to a decrease in the supply of a good at every given price.

    <p>False</p> Signup and view all the answers

    Match the following factors that affect supply with their effects on the supply curve:

    <p>Increase in government taxes = Supply curve shifts inward Improvement in technology = Supply curve shifts outward Expectation of a future price decrease = Supply curve shifts inward Increase in the number of firms in the industry = Supply curve shifts outward</p> Signup and view all the answers

    What is the effect of unfavorable weather conditions on the supply of a good?

    <p>A decrease in supply</p> Signup and view all the answers

    What is the main function of the Reserve Requirements in Monetary Policy?

    <p>To decrease the money supply</p> Signup and view all the answers

    Fiscal and Monetary Policies are mutually exclusive.

    <p>False</p> Signup and view all the answers

    What is the term for the amount of money that banks must hold in reserve?

    <p>Reserve Requirements</p> Signup and view all the answers

    The _______________ is the central bank of the European Union.

    <p>European Central Bank</p> Signup and view all the answers

    Match the following tools of Monetary Policy with their descriptions:

    <p>Open Market Operations = Buying or selling government securities to increase or decrease the money supply Standing Facilities = Lending or borrowing money to banks at a fixed rate Reserve Requirements = Increasing or decreasing the minimum amount of reserves that banks must hold</p> Signup and view all the answers

    The government's budget is always balanced.

    <p>False</p> Signup and view all the answers

    What is the term for the amount of money that people and businesses want to hold?

    <p>Money Demand</p> Signup and view all the answers

    What is the term for the process by which the money supply is increased through the banking system?

    <p>Money Creation and the Money Multiplier</p> Signup and view all the answers

    What happens to the supply curve when there is a rise in costs of production?

    <p>The supply curve shifts to the left</p> Signup and view all the answers

    A rise in costs accompanied by an equivalent rise in productivity will lead to a decrease in supply.

    <p>False</p> Signup and view all the answers

    What is the effect of a fall in the price of a good in competitive supply on the supply of the other good?

    <p>An increase in the supply of the other good</p> Signup and view all the answers

    The conditions of supply refer to those factors held ___________ and include the price of factor inputs or factors of production.

    <p>constant</p> Signup and view all the answers

    What is the effect of a rise in wage rates on the supply of a commodity, assuming no change in productivity?

    <p>It leads to a decrease in supply</p> Signup and view all the answers

    The supply curve shifts to the right when there is a decrease in the price of factor inputs.

    <p>True</p> Signup and view all the answers

    Match the following factors that affect supply with their descriptions:

    <p>Price of factor inputs = Affects the cost of production Price of other goods = Affects the supply of alternative products Productivity = Affects the level of profit available from producing a commodity</p> Signup and view all the answers

    What is the effect of a rise in costs on the supply of a commodity, assuming no change in productivity?

    <p>A decrease in supply</p> Signup and view all the answers

    What is demand in economics?

    <p>The amount of a good or service consumers are willing and financially able to buy at a given price during a period of time</p> Signup and view all the answers

    The law of demand states that the quantity demanded of a commodity will be larger at higher market prices and smaller at lower market prices.

    <p>False</p> Signup and view all the answers

    What is consumer surplus?

    <p>The difference between the maximum a consumer would pay for a good and the price actually paid</p> Signup and view all the answers

    An individual supply curve shows the quantity that __________ is willing and able to sell at different prices.

    <p>one firm</p> Signup and view all the answers

    Match the factor influencing demand with its description:

    <p>Changes in consumer tastes and fashion = Can bring about marked changes in demand Advertising = Intended to stimulate demand shifts rightwards Expectations about the economy = Favorable expectations likely to increase the number of consumers Population size and structure = Larger populations result in more demand and traveling</p> Signup and view all the answers

    Which condition of supply results in a decrease in supply depicted by a leftward shift in the supply curve?

    <p>The price of factor inputs</p> Signup and view all the answers

    A rise in costs of production accompanied by an equivalent rise in productivity will always lead to a decrease in supply.

    <p>False</p> Signup and view all the answers

    Define producers' surplus.

    <p>Producers' surplus is the difference between the minimum price a producer would accept to supply a given quantity of a good and the price actually received.</p> Signup and view all the answers

    Ceteris paribus, a rise in the price of one good will lead to an increase in the supply of the _good.

    <p>other</p> Signup and view all the answers

    Match the condition of supply with its impact on market supply:

    <p>Rise in government taxes = Decrease in supply at every given price Improved technology = Increase in supply at every given price Expectations of future price decrease = Reduction in planned output at every given price</p> Signup and view all the answers

    Study Notes

    Conditions of Supply

    • The conditions of supply refer to factors that are held constant
    • These factors include:
      • The price of factor inputs or factors of production
      • The price of other goods
      • Trade unions
      • Government taxes and subsidies on the firm
      • The state of technology
      • The expectations of future price changes
      • Weather or unforeseen circumstances
      • The number of firms in the industry

    Supply Curve

    • A supply curve shows the relationship between the price of a good and the quantity supplied
    • The supply curve can shift due to changes in the conditions of supply
    • A leftward shift in the supply curve indicates a decrease in supply, while a rightward shift indicates an increase in supply

    Factors Affecting Supply

    • A change in the cost of production will lead to a change in the supply curve
    • A rise in costs will lead to a decrease in supply, while a fall in costs will lead to an increase in supply
    • The price of other goods can also affect the supply curve
    • A fall in the price of a good in competitive supply will lead to an increase in the supply of the other good
    • Trade unions can also affect the supply curve
    • A rise in wages will lead to a decrease in supply, while a fall in wages will lead to an increase in supply

    Retail Price Index (RPI)

    • The RPI is a measure of the average change in prices of a basket of goods and services
    • The RPI is used to measure inflation
    • The RPI is constructed by sampling the prices of a range of goods and services
    • The RPI is used to calculate the rate of inflation

    Inflation

    • Inflation is a sustained increase in the general price level of goods and services in an economy over a period of time
    • Inflation can be caused by a variety of factors, including:
      • Monetarist theory: an increase in the money supply
      • Keynesian theory: an increase in aggregate demand
      • Cost-push or supply-side inflation: an increase in production costs
      • Imported inflation: an increase in the price of imported goods
    • The effects of inflation can be negative, including:
      • A decrease in the purchasing power of money
      • A decrease in the value of savings
      • Uncertainty and inflationary expectations

    Elasticity of Demand

    • Elasticity of demand is a measure of how responsive the quantity demanded of a good is to a change in its price
    • Elasticity of demand can be measured using the formula: elasticity of demand = percentage change in quantity demanded / percentage change in price
    • Elasticity of demand can vary along the demand curve, with demand being more elastic at higher prices and less elastic at lower prices

    Income Elasticity of Demand

    • Income elasticity of demand is a measure of how responsive the quantity demanded of a good is to a change in income
    • Income elasticity of demand can be measured using the formula: income elasticity of demand = percentage change in quantity demanded / percentage change in income
    • Income elasticity of demand can vary depending on the type of good, with normal goods having a positive income elasticity of demand and inferior goods having a negative income elasticity of demand

    Producers' Surplus

    • Producers' surplus is the difference between the minimum price a producer would accept to supply a given quantity of a good and the price actually received
    • Producers' surplus is a measure of the profit made by producers

    Taxation

    • Taxation is a means of raising revenue for the government
    • There are different types of taxes, including direct and indirect taxes
    • Direct taxes are levied on income and wealth, while indirect taxes are levied on goods and services
    • The government uses taxation to redistribute income and wealth, and to influence economic activity

    Fiscal Policy

    • Fiscal policy is the use of government spending and taxation to influence the overall level of economic activity
    • Fiscal policy can be used to stabilize the economy, promote economic growth, and reduce unemployment
    • The government uses fiscal policy to manage aggregate demand and prevent inflation

    Monetary Policy

    • Monetary policy is the use of the money supply and interest rates to influence the overall level of economic activity
    • Monetary policy is used to promote economic growth, stability, and low inflation
    • The central bank uses monetary policy to regulate the money supply and interest rates, and to maintain financial stability

    Inflation Measurement

    • Inflation is measured using the Retail Price Index (RPI)
    • The RPI is a basket of goods and services that is representative of the average consumer's expenditure
    • The RPI is used to calculate the rate of inflation, which is the percentage change in the price level over a period of time

    Demand

    • Demand is the amount of a good or service consumers are willing and financially able to buy at a given price during a period of time.
    • Effective demand is when wants are backed up by the financial ability to buy.
    • The law of demand states that if other things do not change, the quantity demanded of a commodity will be smaller at higher market prices and larger at lower market prices.
    • Utility is the satisfaction people get from consuming or using a good or service.
    • The law of diminishing marginal utility states that the extra units consumed of any good or service usually yield less and less additional utility.

    Individual Demand Curve and Market Demand Curve

    • An individual's demand is one buyer's demand for a good.
    • Market demand is the total amount demanded by each consumer at that price.
    • A market demand curve is the horizontal summation of all individual demand curves.
    • It shows the amount of a good demanded at different prices during a specific period of time.

    Movements along the Demand Curve and Shifts in the Demand Curve

    • Movement along the demand curve occurs when the price changes and there is no change in other factors influencing demand (ceteris paribus).
    • A change in the product's own price (caused by a change in supply) never shifts the demand curve for that good.
    • If something other than price changes (so that the ceteris paribus condition is violated), then there is a change in demand and the demand curve shifts.

    Factors Influencing Demand

    • Real disposable income of consumers
    • Price of substitutes or goods in competitive demand
    • Price of complements or goods in joint demand
    • Consumer tastes and fashion
    • Advertising
    • Expectations about the economy
    • Population size and structure
    • Religious beliefs

    Exceptional Demand Curves

    • Veblen goods: demand increases as price rises due to conspicuous consumption.
    • Goods with uncertain product quality: demand increases as price rises due to consumer ignorance.
    • Giffen goods: demand increases as price rises, often due to subsistence economies and basic necessities.

    Consumer Surplus

    • Consumer surplus is the difference between the maximum a consumer would pay for a good and the price actually paid.
    • It is shown by the area above the price line and below the demand curve.

    Supply

    • Supply is the amount of a good that producers in an industry are both willing and able to sell at a given price during a period of time.

    Individual Supply and Market Supply

    • An individual supply curve shows the quantity that one firm is willing and able to sell at different prices.
    • A market supply curve is the total amount that will be supplied by all firms in the industry at different prices during a period of time.

    Movements along the Supply Curve and Shifts in the Supply Curve

    • Movement along the supply curve occurs when the price changes and there is no change in other factors influencing supply (ceteris paribus).
    • A change in the price of a good never shifts the supply curve for that good.
    • If something other than price changes (so that the ceteris paribus condition is violated), then there is a change in supply and the supply curve shifts.

    Factors Influencing Supply

    • Price of factor inputs or factors of production
    • Price of other goods (competitive supply or joint supply)
    • Government taxes and subsidies on the firm
    • State of technology
    • Expectations of future price changes
    • Weather or unforeseen circumstances
    • Number of firms in the industry

    Producers' Surplus

    • Producers' surplus is the difference between the minimum price a producer would accept to supply a given quantity of a good and the price actually received.

    Determination of Market Price

    • In a free or uncontrolled market, prices are determined by the interaction of demand and supply.
    • The market equilibrium price is the price at which there is no reason for anything to change unless disturbed by an outside shock.

    Changes in Market Equilibrium Price

    • Changes in market equilibrium price must be due to changes in demand or supply, or both.
    • Changes in demand or supply can cause changes in the market equilibrium price.

    Importance of Ceteris Paribus Condition

    • The 'ceteris paribus' condition is a Latin term that means 'all other things remaining the same'.

    • It is important to remember that the effect of a change in price depends on the cause.### Ceteris Paribus

    • Ceteris paribus allows us to isolate the factor of interest and investigate its impact on another variable by holding all other relevant factors constant.

    • It enables us to understand the effect of a change in one factor on the dependent variable, assuming all other factors remain constant.

    Economic Theory and Experiments

    • In laboratory sciences, experiments are conducted to hold all other relevant factors constant, except for the one under investigation.
    • In economics, it's difficult to isolate the effect of a single factor as multiple factors vary simultaneously.

    Conclusions

    • Changes in demand or supply conditions push the system into disequilibrium, leading to changes in equilibrium prices.
    • The market price is automatically moved towards equilibrium by forces at work.
    • Products with unstable demand and supply conditions are subject to greater price fluctuations.
    • The effect of a rise in price on equilibrium output depends on the cause.

    The Price Mechanism

    • The price mechanism responds to shortages and surpluses, causing prices to rise or fall.
    • The price mechanism ensures convergence towards equilibrium.
    • An efficient price mechanism fulfills three functions:

      Signalling Function

      • A rise in price signals suppliers to produce more of the product.

      Incentive Function

      • A price rise provides an incentive for firms to reallocate resources and increase production.

      Rationing Function

      • The price mechanism rations out the available supply as the price rises.

    Society's Welfare

    • At the market equilibrium price, society's welfare (the summation of consumers' and producers' surpluses) is at its greatest.
    • Price control results in an unequal shift of surplus from one group to another, leading to a deadweight loss in society's welfare.

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    Description

    This quiz is based on Figure 2.4(a) which illustrates movements along a stationary supply curve, demonstrating the relationship between price and quantity. Test your understanding of microeconomic concepts.

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