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Chapter 4: Supply and Demand Chapter 4: Supply and Demand Questions for Thought and Review The law of supply states that quantity supplied rises as price increases or, alternatively, that quantity supplied falls as price decreases. Price is directly related to quantity supplied because, as price rises, people and firms rearrange their activities to supply more of that good in order to take advantage of the higher price. 4. A change in the price causes a movement along the demand curve, a movement to a new point on the same curve. A shift in the demand curve means that the quantities will be different at all prices; the entire curve shifts. 6. Shift factors of supply include the price of inputs, technological advances, changes in expectations, and taxes and subsidies. As the price of inputs increase, the supply curve shifts to the left. As technological advances are made that reduce the cost of production, the supply curve shifts to the right. If a supplier expects the price of her good to rise, she may decrease supply now to save and sell later. Other expectational effects are also possible. Taxes paid by suppliers shift the supply curve to the left. Subsidies given to producers shift the supply curve to the right. 8. In the accompanying graph, the demand curve has shifted to the left, causing a decrease in the market price and the market quantity. Price 2. S P0 P1 D1 Q1 D0 Q0 Quantity Sales volume increases (equilibrium quantity rises) when the government suspends the tax on sales by retailers because the price to demanders falls and hence equilibrium quantity demanded rises. This occurs because the supply curve shifts to the right because suppliers do not have to pay taxes on their sales (cost of production declines). S0 Price 10. S1 P0 P1 D Q0 Q1 Quantity 12. Customers will flock to stores demanding that funky “economics professor” look, creating excess demand. This excess demand will soon catch the attention of suppliers, and prices will be pushed upward. 14. Because the price of gas rose significantly, we’d expect people to purchase fewer gasguzzlers and more fuel-efficient cars such as diesel cars. 1 Chapter 4: Supply and Demand 16. It suggests that the job is being rationed, which means that the wage is above the equilibrium wage. 18. The fallacy of composition is the false assumption that what is true for a part will also be true for the whole. It affects the supply/demand model by drawing our attention to the possibility that supply and demand are interdependent. Feedback effects must be taken into account to make the analysis complete. 20. The greatest feedback effects are likely to occur in the markets that are the largest. This is most likely to be true for housing and manufactured-goods markets. Chapter 4: Problems and Exercises 22. a. The market demand and market supply curves are shown in the accompanying graph. b. At a price of $37, quantity demanded is 32 and quantity supplied is 18. Excess demand is 14. At a price of $67, quantity demanded is 10 and quantity supplied is 46. Excess supply is 36. c. Equilibrium price is $47. Equilibrium quantity is 24. S0 26. a. The tax shifts the supply curve to the left because it increases the cost of supplying the natural gas abroad. Equilibrium price rises while equilibrium quantity declines. b. The tax will likely reduce the price of natural gas in Argentina as more gas is diverted to the domestic market. c. It depends; it will have a tendency to push it up, but probably since Argentina is such a small percentage of the world market, the effect would be difficult to distinguish. S1 P0 P1 D0 Q0 Q1 Quantity of wheat S1 Price Price of wheat 24. a. I would expect wheat prices to decline since the supply of wheat is greater than expected. Wheat commodity markets are very competitive, so the initial 35 percent increase in output was already reflected in the current price of wheat. It is only the additional 9 percent increase that will push down the price of wheat. b. This is graphically represented by a shift to the right in the supply of wheat, as shown in the accompanying graph. Equilibrium price falls from P0 to P1 while equilibrium quantity rises from Q0 to Q1. S0 P1 P0 D Q1 Q0 Quantity 2 Chapter 4: Supply and Demand S1 Price 28. a. It would likely raise the value significantly – it was estimated that it would raise it to $50,000 a sheet. See the accompanying graph. Demand shifts to the right as people realize the oddity of the stamp. Supply shifts to the left because of the recall. b. It would probably lower the value of the stamps – it was estimated that it would lower the price of the sheet to $100 a sheet. In the accompanying graph, the supply curve shifts back to S0 and the price declines to P2. We’ve shown the demand curve remaining high, though it might shift back to the left. c. They would likely sue; they did and they lost. S0 P1 P2 D1 P0 D0 Q0 Q1 Quantity 30. a. Because the market for pencils is relatively small, supply/demand analysis would be appropriate without modification. Also, there are no significant political or social forces that would affect the analysis. b. Because the labor market is very large, supply/demand analysis would not be appropriate without modification. For example, an increase in labor supply will likely lead to greater income and greater demand for goods, which will lead to an increase in quantity of goods produced and therefore an increase in the demand for labor. In this case there are significant feedback effects. c. Aggregate markets such as savings and expenditures include feedback effects, so supply/demand analysis would not be appropriate without modification. d. The CD market is relatively small. Supply/demand analysis would be appropriate without modification. Chapter 4: Web Questions The answers to these questions will depend upon the current “Short-Term Energy Outlook.” The answer given here should be used as a guide. a. Continued problems with local refineries and increased global demand for oil means that oil prices are expected to rise. b. World oil prices are forecast to rise. The effect of the supply and demand factors on price and quantity are shown in the accompanying graph. Price rises by a lot. What happens to quantity depends on the relative size of the shifts. c. Higher crude oil, an input to the production of gasoline, and higher seasonal demand for gas will increase its price in the near term. As the market enters summer, demand for heating oil and natural gas will decline, leading to lower prices. S1 Price 2. S0 P1 P0 D0 Q1Q 0 3 D1 Quantity