Chapter 03 – Demand, Supply and Market Equilibrium
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Chapter 03 Demand, Supply and Market Equilibrium
Questions
1. Explain the law of demand. Why does a demand curve slope downward? How is a market
demand curve derived from individual demand curves? LO1
Answer: As prices change because of a change in supply for a commodity, buyers will
change the quantity they demand of that item. If the price drops, a larger quantity will be
2. What are the determinants of demand? What happens to the demand curve when any of these
determinants change? Distinguish between a change in demand and a movement along a fixed
demand curve, noting the cause(s) of each. LO1
Answer: The fundamental determinant of demand is the price of the commodity under
consideration: a change in price causes movement along the commodity’s demand curve.
This movement is called a change in quantity demanded. Decreased price leads to
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3. What effect will each of the following have on the demand for small automobiles such as the
Mini-Cooper and Smart car? LO1
a. Small automobiles become more fashionable.
b. The price of large automobiles rises (with the price of small autos remaining the same).
c. Income declines and small autos are an inferior good.
d. Consumers anticipate that the price of small autos will greatly come down in the near future.
e. The price of gasoline substantially drops.
Answer: Demand increases in (a), (b), and (c); decreases in (d). The last one (e) is
ambiguous. As autos and gas are complements, one could argue that the decrease in gas
4. Explain the law of supply. Why does the supply curve slope upward? How is the market supply
curve derived from the supply curves of individual producers? LO2
Answer: As prices rise because of increased demand for a commodity, producers find it
more and more profitable to increase the quantity they offer for sale; that is, the supply
5. What are the determinants of supply? What happens to the supply curve when any of these
determinants changes? Distinguish between a change in supply and a change in the quantity
supplied, noting the cause(s) of each. LO2
Answer: The fundamental determinant of supply is the price of the commodity. As price
increases, the quantity supplied increases. An increase in price causes a movement up a
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6. What effect will each of the following have on the supply of auto tires? LO2
a. A technological advance in the methods of producing tires.
b. A decline in the number of firms in the tire industry.
c. An increase in the prices of rubber used in the production of tires.
d. The expectation that the equilibrium price of auto tires will be lower in the future than
currently.
e. A decline in the price of the large tires used for semi trucks and earth-hauling rigs (with no
change in the price of auto tires).
f. The levying of a per-unit tax on each auto tire sold.
g. The granting of a 50-cent-per-unit subsidy for each auto tire produced.
Answer:
Part a: Supply will increase because the technological advance allows the tire
manufacturers to produce more tires using the same amount of inputs.
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7. “In the corn market, demand often exceeds supply and supply sometimes exceeds demand.”
“The price of corn rises and falls in response to changes in supply and demand.” In which of
these two statements are the terms “supply” and “demand” used correctly? Explain. LO2
Answer: In the first statement “supply” and “demand” are used incorrectly. Supply and
demand are both schedules or curves that intersect where quantity supplied and quantity
8. In 2001 an outbreak of foot-and-mouth disease in Europe led to the burning of millions of
cattle carcasses. What impact do you think this had on the supply of cattle hides, hide prices, the
supply of leather goods, and the price of leather goods? LO4
Answer: The supply of cattle hides was reduced, raising the price of hides. Because
9. Critically evaluate: “In comparing the two equilibrium positions in Figure 3.7b, I note that a
smaller amount is actually demanded at a lower price. This refutes the law of demand.” LO4
Answer: The key point here is that the second equilibrium occurs after demand has
decreased, that is demand has shifted because of a change in determinants, which has
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10. For each stock in the stock market, the number of shares sold daily equals the number of
shares purchased. That is, the quantity of each firm’s shares demanded equals the quantity
supplied. So, if this equality always occurs, why do the prices of stock shares ever change? LO4
Answer: During any given stock trading session, there will be both prospective buyers
and sellers, each willing to buy or sell a certain number of shares depending on price. If
11. Suppose the total demand for wheat and the total supply of wheat per month in the Kansas
City grain market are as shown in the nearby table. Suppose that the government establishes a
price ceiling of $3.70 for wheat. What might prompt the government to establish this price
ceiling? Explain carefully the main effects. Demonstrate your answer graphically. Next, suppose
that the government establishes a price floor of $4.60 for wheat. What will be the main effects of
this price floor? Demonstrate your answer graphically. LO5
Answer: The equilibrium price is found where quantity supplied equals quantity
demanded. This occurs at the price of $4.00 where 75 thousand bushels are demanded
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12. What do economists mean when they say “price floors and ceilings stifle the rationing
function of prices and distort resource allocation”? LO5
Answer: When unrestrained, prices rise and fall to correct imbalances between the
quantity supplied and quantity demanded in a market. If sellers find themselves at a
given price with more output than consumers are willing to purchase, the price will fall.
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13. LAST WORD In some countries, such as France, every corpse is available for doctors to
“harvest” for organs unless the deceased, while still alive, signed a form forbidding the organs to
be harvested. In the USA, it is the opposite: No harvesting is allowed unless the deceased had
signed, while still alive, an organ donor form authorizing doctors to harvest any needed organs.
Use supply and demand figures to show in which country organ shortages are likely to be less
severe.
Answer: In France every corpse is available for doctors to “harvest” for organs unless
the person signed a form while he was still alive, forbidding his organs to be harvested.
Evidence from behavioral economics suggests that people are more likely to opt into the
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Problems
1. Suppose there are three buyers of candy in a market: Tex, Dex, and Rex. The market demand
and the individual demands of Tex, Dex, and Rex for candy are given in the table below. LO1
a. Fill in the table for the missing values.
b. Which buyer demands the least at a price of $5? The most at a price of $7?
c. Which buyer’s quantity demanded increases the most when the price is lowered from $7 to $6?
d. Which direction would the market demand curve shift if Tex withdrew from the market? What
if Dex doubled his purchases at each possible price?
e. Suppose that at a price of $6, the total quantity demanded increases from 19 to 38. Is this a
“change in the quantity demanded” or a “change in demand”?
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Feedback: Consider the following set of values:
Part a: At each price (row) the total quantity demanded will equal the sum of the
individual quantities demanded. To find the total quantity demanded at the price of $8
add the quantities demanded by Tex, Dex, and Rex, which equals 4 (= 3 + 1 + 0). To find
Rex’s quantity demanded at the price of $7, we use the same logic as above. The sum of
2. The figure below shows the supply curve for tennis balls, S1, for Drop Volley tennis, a
producer of tennis equipment. Use the figure and the table below to give your answers to the
following questions. LO2
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a. Use the figure to fill in the quantity supplied on supply curve S1 for each price in the table
below.
b. If production costs were to increase, the quantities supplied at each price would be as shown by
the third column of the table (“S2 Quantity Supplied”). Use that data to draw supply curve S2 on
the same graph as supply curve S1.
c. In the fourth column of the table, enter the amount by which the quantity supplied at each price
changes due to the increase in product costs. (Use positive numbers for increases and negative
numbers for decreases.)
d. Did the increase in production costs cause a “decrease in supply” or a “decrease in quantity
supplied”?
Feedback: Consider the following figure and values.
Chapter 03 – Demand, Supply and Market Equilibrium
Part a: The quantity supplied is 15 at $3, 10 at $2, and 5 at $1. This is found by reading
the values of the supply curve.
Part b: Graph
3. Refer to the expanded table below from question 11. LO3
a. What is the equilibrium price? At what price is there neither a shortage nor a surplus? Fill in
the surplus-shortage column and use it to confirm your answers.
b. Graph the demand for wheat and the supply of wheat. Be sure to label the axes of your graph
correctly. Label equilibrium price P and equilibrium quantity Q.
c. How big is the surplus or shortage at $3.40? At $4.90? How big a surplus or shortage results if
the price is 60 cents higher than the equilibrium price? 30 cents lower than the equilibrium price?