Chapter 3 1Supply and Demand: An Initial Look




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^ ESSAY QUESTIONS

285. Consumers expressed outrage at the high price of chainsaws after Hurricane Andrew hit Florida and Louisiana, with newspaper editorials accusing suppliers of unconscionable price gouging. Use a supply and demand graph to assist in explaining the increase in the price of chain saws after Hurricane Andrew.

^ ANSWER: M, A

An increase in the number of downed trees led to an increase in the demand for chain saws. When demand increases and supply is unchanged, equilibrium price and quantity increase (Figure 3-23). “Gouging” may be nothing more than a higher equilibrium price due to an increase in demand.

^ Figure 3-23





286. After Hurricane Andrew hit Florida and Louisiana, consumers expressed outrage at the high prices being charged for chainsaws, generators, and bottled water. If governments followed the consumers’ demands and imposed price ceilings in these markets, what is the likely result?

^ ANSWER: D, A

Effective price ceilings (i.e., price ceilings set below the equilibrium price) will cause a chronic shortage of the goods, leading to black markets, greater profits for illicit suppliers, and (probably) higher prices than would exist in a free market. Additionally, the quantities supplied of these goods will be lower than in a free market, making people worse off than they otherwise would be.

287. Producers were accused of price gouging as the price of bottled water soared after Hurricane Andrew. Consumers clamored for price controls to keep bottled water at pre-Andrew levels. Use supply and demand analysis to graphically show the effect of setting a price ceiling on bottled water after Hurricane Andrew at the pre-hurricane equilibrium price. Use your graph to assist in explaining the likely unintended effects of such a price control. Be sure that your graph is completely and correctly labeled.

^ ANSWER: M, A

Figure 3-24





As a result of contaminated public water, consumers substituted bottled water, increasing the demand for bottled water (Figure 3-24). If the market is unfettered, equilibrium price and quantity will increase, assuming supply is unchanged. Holding price at pre-Andrew levels would cause a shortage, as quantity supplied would be unchanged from pre-Andrew levels while demand increased. Unintended side effects would include long lines for bottled water and black markets where bottled water would be sold for far more than the legislated price.

288. The following are common errors students make when discussing supply and demand. What is the mistake in each?

a. At equilibrium, demand equals supply.

b. The quantity of demand is greater than the quantity of supply.

c. They move along the line from both ends to an equilibrium in the middle.

d. The increase in demand causes an increase in supply.

^ ANSWER: M, I

a. Demand never equals supply. At the equilibrium price, quantity demanded equals quantity supplied.

b. Quantity of demand is a meaningless term in economics. The proper term is “quantity demanded.”

c. This phrase is apparently an attempt to graphically describe supply and demand. However, it is difficult to understand and does not describe the process whereby a market reaches an equilibrium.

d. An increase in demand would lead to an increase in quantity supplied, but not an increase in supply. There would be a movement along the supply curve to a new quantity supplied at a higher price. Only one curve, either supply or demand, will shift at one time, causing equilibrium to move alone the other curve.

289. Distinguish between scarcity and shortage.

^ ANSWER: M, I

Scarcity implies that people want more of a good than is freely available. Shortage implies that people want more than is available at the going price. All economic goods are scarce, whereas there are shortages only in the presence of price ceilings that set price below equilibrium levels.

290. Distinguish between demand and quantity demanded. Do the same for supply and quantity supplied.

^ ANSWER: E, R

Quantity demanded is the number of units consumers want to buy at a specific price over a specified period. It depends upon the price charged. Demand, or a demand schedule, shows how the quantity demanded of some product during a specified period will change as the price of the product changes, holding all other determinants of quantity demanded constant. On a demand curve, quantity demanded is a single point.

Similarly, quantity supplied is the number of units sellers are willing to sell over a specified period at a specific price. Supply, or a supply schedule, is a table showing how the quantity supplied of some product during a specified period changes as the price of the product changes, holding all other determinants of quantity supplied constant. In a supply curve, quantity supplied is a single point.

291. Define the following terms and explain their importance to the study of economics.

a. demand

b. surplus

c. equilibrium

d. law of supply and demand

e. quantity demanded

^ ANSWER: E, R

a. Demand is a schedule that indicates how much consumers are willing and able to buy at different prices during a specified period. There may be individual and market demand schedules. Demand is central to the study of a market system.

b. A surplus exists in a market when the price is above the equilibrium, so the quantity supplied is greater than the quantity demanded. A surplus will normally cause the price to fall.

c. Equilibrium is a situation in which there are no inherent forces that produce change. A market is not necessarily always at equilibrium, but we expect it to move toward equilibrium.

d. The law of supply and demand suggests that a market will always move toward equilibrium, at which quantity supplied equals quantity demanded. Although there may be cases in which this does not occur, we expect it to be generally true.

e. The quantity demanded of a good or service depends on its price. This is, graphically, one point on a demand curve. Other factors that determine quantity demanded include income of buyers, population size, tastes, and prices of other products (substitutes and complements).

292. The demand for home computers has increased, yet the price has fallen. Explain this apparent paradox.

^ ANSWER: E, A

Supply has increased by more than demand has increased. The technological advance in computer chips has led to a huge increase in supply, more than enough to counteract any upward pressure on price due to the increase in demand.

293. “The market has failed to provide enough rental housing in New York City. This demonstrates another failure of free markets—they may lead to shortages of necessities.” Explain why you agree or disagree.

^ ANSWER: M, A

An economist would disagree. The free market leads to equilibrium, at which quantity demanded equals quantity supplied. There are neither shortages nor surpluses at the equilibrium point. The NYC shortage of rental housing is a result of rent ceilings, which interfere with the ability of the market to allocate scarce resources.

294. Motels along Myrtle Beach, Florida, charge $100 a night in the summer but sometimes as little as $25 a night in the winter. Use supply and demand analysis, including graphical and verbal explanation, for these winter “sales.”

ANSWER M

Figure 3-25





A sample graph is shown (Figure 3-25). As with the airline example, demand falls in the winter, so that equilibrium price decreases with the supply unchanged—a shift of demand to the left and a lower price and quantity in winter months.

295. Show graphically the effect of technological advance on the price of compact discs. In a separate graph show what happens to the price of cassette tapes as a secondary effect of the new CD technology.

^ ANSWER: M, A

Figure 3-26





The first graph shows a rightward shift of the supply of CDs as a result of cheaper production methods, so that the price of CDs falls while equilibrium quantity increases (Figure 3-26). This causes a decrease in the demand for cassettes, reducing price (and quantity at equilibrium).

296. The demand for a textbook written by Schwarz and Mobley is Q = 20,000 – 100P; supply is Q = 2,000 + 200P. Students complain about the high price of textbooks, resulting in a price ceiling and, unfortunately, a shortage of texts. Below what price will shortages occur?

^ ANSWER: M, A

A shortage will occur if the price ceiling is below the equilibrium price. Equilibrium price is where quantity demanded equals quantity supplied. At this point,

20,000 – 100P = 2,000 + 200P

Solving, P = 60. If price is mandated below $60, there will be a shortage.

297. Suppose demand can be described with the equation Q = 900 – 5P and supply with the equation Q = 100 + 5P.

a. Determine the equilibrium price and quantity.

b. Determine the surplus or shortage if the price were $100.

^ ANSWER: M, A

a. Equate the supply and demand as follows:

100 + 5P = 900 – 5P

800 = 10P

P = $80

Quantity is determined from the demand relationship by inserting $80 for P:

Q = 900 – 5(80) = 900 – 400 = 500

b. At a price of $100, the quantity demanded:

Q = 900 – 5(100) = 900 – 500 = 400

The quantity supplied:

Q = 100 + 5(100) = 100 + 500 = 600

The quantity supplied exceeds the quantity demanded by 200. There is a surplus.

298. Draw a graph of a market in equilibrium. Describe what might cause a change in demand or supply and how this would affect the diagram. Indicate how the equilibrium price and quantity will change.

^ ANSWER: E, A

The (completed) diagram should look like Figure 3-3 in the text. Effects that might change demand include a change in population, income of buyers, tastes, and prices of related goods (substitutes and complements). Effects that might change supply include the size of the industry (entry or exit of new firms), technological progress, prices of inputs, and prices of related goods.

299. Suppose demand can be described with the equation Q = 900 – 5P and supply with the equation Q = 100 + 5P. Complete the following table. Determine the equilibrium price and quantity.

Quantity Quantity Surplus/

^ Price Demanded Supplied Shortage

$100 _____ _____ _____

95 _____ _____ _____

90 _____ _____ _____

85 _____ _____ _____

80 _____ _____ _____

75 _____ _____ _____

70 _____ _____ _____

65 _____ _____ _____

60 _____ _____ _____


^ ANSWER: M, A

Quantity Quantity Surplus/

Price Demanded Supplied Shortage

$100 400 600 +200

95 425 575 +150

90 450 550 +100

85 475 525 +50

80 500 500 0—EQUILIBRIUM

75 525 475 –50

70 550 450 –100

65 575 425 –150

60 600 400 –200

300. Define equilibrium as it relates to markets. Describe the process by which a market reaches a new equilibrium. Include an appropriate diagram.

^ ANSWER: M, A

The diagram should look like Figure 3-3 in the text. Equilibrium is a situation in which there are no inherent forces that produce change. The price and quantity tend to remain the same, unless some underlying force enters the picture.

If a market is not at equilibrium, there will be a surplus or shortage at the existing price. To remove the surplus or shortage, the price will have to change, leading to a change in the quantity demanded and quantity supplied. A shortage will drive the price up to equilibrium, while a surplus will drive the price down to equilibrium. Price will continue to change until quantity demanded equals quantity supplied and there is no surplus or shortage.

301. Give an example of a price floor. Draw a corresponding diagram and explain why there is a continuing surplus.

^ ANSWER: M, A

The example used in the text is price supports for agriculture, such as milk. A diagram should look like Figure 3-12 in the text. Quantity supplied exceeds quantity demanded, but price is not allowed to fall. Therefore, there is an ongoing market surplus.

302. Give an example of a price ceiling. Draw a corresponding diagram and explain why there is a continuing shortage.

^ ANSWER: M, A

The example used in the text is rent controls. A diagram should look like Figure 3-11 in the text. Quantity supplied is less than quantity demanded, but price is not allowed to rise. Therefore, the shortage continues.

303. In some markets, demand can be approximated by

Q = 50 – 5P + 10Y

where Q is quantity, P price per unit, and Y buyers = income. Supply can be approximated by

Q = –5 + 10P.

a. If Y = 20, what is equilibrium price and output?

b. If Y rises to 25, what is the new equilibrium price and output?

ANSWER: M, A

a. Equate the supply and demand equations, substituting 20 for Y:

50 – 5P + 10(20) = –5 + 10P

50 + 200 + 5 = 15P

P = 17, Q = 165

b. Equate the supply and demand equations, substituting 25 for Y:

50 – 5P + 10(25) = –5 + 10P

50 + 250 + 5 = 15P

P = 20.33, Q = 198.33


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