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ECON1001
Tutorial 3
Q1
Your economics professor told you that the quantity
demanded of a good is higher when prices are lower, and the
quantity demanded is lower when prices are higher. But you
can think of a lot of people who would rather shop in an
upscale mall than in a discount warehouse. This is
A) inconsistent with the economic model because it shows that people
are irrational.
B) evidence that the abstract economic model of demand does not
apply in the real world.
C) because malls and warehouse stores are two different markets, so
have different demand curves.
D) because the supply curve is more important in determining where
people like to shop.
E) because the people you know have not studied economics.
Ans: c
Law of Demand
• P↑(↓)  Qd ↓(↑)
• Negative relationship
• Purchase behavior within ONE market
• What is ONE MARKET/ ONE PRODUCT?
Are they the same product?
• Watch: Swatch vs Rolex
• Clothing: Giordano vs Gucci
• Bags: Nike vs L.V.
What kind of goods to include in a market depends on the
purpose/scope of our analysis. Sometimes, close substitutes are
grouped in the same market (i.e., the same product). Sometimes,
we may not even distinguish Swatch and Rolex although they have
very different customer bases.
However, in Q1, the information suggested that the goods sold in
the upscale and discount warehouse should be treated as two
markets. That is, we can make sense of the observed phenomenon
only when they are treated as two markets.
Option D
• “because the supply curve is more important in
determining where people like to shop.”
• The observation and this reason make little
sense only if the supply of upscale is more than
that of discount warehouse. That is, more
people end up shopping in the upscale stores –
at equilibrium.
• However, it does not seem reasonable to
assume that the supply of upscale store is more
than that of discount warehouse (or the cost of
upscale store is lower than that of discount
warehouse).
Q2 Gertie saw a pair of jeans that she was
willing to buy for $35. The price tag, though,
said they were $29.99. Therefore,
A) Gertie should not buy the jeans because they will be of
lower quality than she expected
B) Gertie should not buy the jeans because the price is
not equal to her reservation price.
C) Gertie should only buy the jeans if she can negotiate a
better price with the salesperson.
D) Gertie should buy the jeans because the price is less
than her reservation price.
E) Gertie should buy the jeans because the price is more
than her reservation price.
Ans: d
Buyer’s Reservation Price
• Definition:
“the max price the consumer is willing to pay for an
extra unit of product”
• Not that the vertical interpretation of demand curve is
Marginal Benefit of consuming that unit.
Buyer’s Reservation Price
• Decision to make:
unit of purchase
• Cost-benefit principle suggests that buyers should buy
an additional unit only if the marginal benefit (reservation
price) is larger than marginal cost (price paid).
• Decision Rule:
Market Price ≤ Reservation Price
 BUY
Market Price > Reservation Price
 NOT BUY
Buyer’s Economic Surplus
• Economic surplus to buyers (MB-MC) is also called “Consumer
Surplus” for an additional unit.
Market Price < Reservation Price
 positive consumer surplus
for that MARGINAL UNIT
Market Price = Reservation Price
 zero consumer surplus
for that MARGINAL UNIT
• Usually Marginal Benefit curve: downward sloping
– Thus buying up to marginal unit:
P=MB
– Note that when P=MB, it does not matter whether the buyers
purchase the additional unit (because it does not change the total
economic surplus to the buyers).
Q3 Which of following is not true of
an equilibrium price?
A) Consumers who are willing to pay the
equilibrium price can acquire the good.
B) It measures the value of the last unit sold to
consumers.
C) It is always a fair and just price.
D) Firms who are willing to accept the equilibrium
price can sell what they produce.
E) It measures the cost of resources required to
produce the last unit.
Ans: c
Meaning of Equilibrium Price
Price
P*
Q*
• Market equilibrium is
the price-quantity pair
Supply
at which both buyers
and sellers are
satisfied.
• P*: criterion to
separate winners
from losers in market
• i.e. who is able to get
the good?
• Those buyers who
Demand
are willing to pay P*
Quantity • Those sellers who
are willing to receive
P*
Meaning of Equilibrium Price
At equilibrium,
Price
Supply=MC
• P=MB for marginal
unit of
consumption
• P=MC for marginal
unit of production
P*
Demand=MB
• There is no cash on
the table.
Quantity
Q*
Option C
• “(equilibrium price) is always a fair and just price”
• Fair/ just? How to justify?
• Fairness or just is a normative judgment. The criteria is
difficult to formalize. Rationality assumption says that
our goal is to maximize total economic surplus.
• The only criteria to judge the market equilibrium is the
concept of optimality, i.e., whether total economic
surplus is maximized at the equilibrium. The market
equilibrium is socially optimal
– if there is no external cost not borne by the sellers
and
– if there is no benefit not accrued to the buyers.
Q4 You have noticed that there is a persistent
shortage of English teachers in Hong Kong.
Based on this observation, you suspect that
A) The wage for English teachers is higher than the wage
of Chinese teachers.
B) The wage for English teachers is lower than the
equilibrium wage.
C) There is an excess supply of English teachers.
D) The wage for English teachers is the equilibrium wage,
but teachers don't apply economic concepts.
E) The reservation price among English teachers is lower
than for other professions.
Ans: b
Persistent shortage
• Price is persistently/ effectively kept below
equilibrium
• Qd > Qs at that price level
• Usually resulted from ‘gov’t intervention’
(if no price floor/ ceiling, price will go to
equilibrium by market forces)
A) ”The wage for English teachers is higher than the wage
of Chinese teachers.”
 difficult to compare because these are two different
markets.
C) ”There is an excess supply of English teachers.”
 because excess supply and shortage are two
opposite concepts. Excess supply means no shortage
and shortage means no excess supply.
E)
The reservation price among English teachers is lower
than for other professions.
 difficult to compare because these are two different
markets (E teachers and other professions). Whether
there is a shortage depends on price, supply and
demand. “reservation price among English teachers”
is only a supply side story.
Q5 Which of the following would cause
an increase in quantity supplied of wheat?
A) The price farmers receive for their wheat rises.
B) The price of fertilizer farmers' use in their fields
decreases.
C) The price firms pay for liability insurance falls.
D) New, better technology for farming are
introduced.
E) Transportation costs for the wheat decreased.
Ans: a
Increase Quantity Supplied
≠increase Supply
Increase Quantity
Supplied = ↑Qs
P
S
P2
P1
Q
Q1
Q2
Only the “ONGOING”/Current
MARKET PRICE
can change Qs
Increase Quantity Supplied
≠increase Supply
P
S1
S2
Q
Increase Supply
= shift the
WHOLE curve
 lots of factors
(more on Q7)
Other options
B) The price of fertilizer farmers' use in their fields
decreases.
 CHEAPER production cost
 shift down Supply Curve
C) The price firms pay for liability insurance falls.
 lower cost of supply additional unit
 shift down Supply Curve
Other options
D) New, better technology for farming are
introduced.
 more efficient prod method LOWER prod
cost for additional unit
 shift down Supply Curve
E) Transportation costs for the wheat decreased.
 CHEAPER prod
 shift down Supply Curve
Q7 What might cause Supply to shift from the
Original Supply to the New Supply?
e ofprice
a cup of coffee
A) A storm in South America
wipes out the entire coffee
crop.
B) New technology reduces the
amount of coffee beans
New Supply
necessary to make a goodtasting pot of coffee.
C) A news report that coffee
consumption greatly
increases productivity.
D) An increase in the price of tea.
E) An increase in the coffee
drinking population.
Original Supply
$3.50
3.00
2.50
2.00
1.50
1.00
New Demand
$ .50
0
Ans: b
Original Demand
10 20 30 40
50
60 70
Cups sold in an hour
Factors that shifts Supply CURVE
•
•
•
•
•
Technology
Cost of production
Weather
Number of suppliers
Price EXPECTATIONS
A)
A storm in South America wipes out the
entire coffee crop.
 At each & every market
price, quantity supplied
DROPS
P
S2
S1
 i.e. Supply decreases
 Supply curve shifts left / up
Q
B) New technology reduces the amount of
coffee beans necessary to make a good-tasting
pot of coffee.
P
S1
S2
 At each & every market
price, sellers can produce
higher quantity with respect
to production cost
 i.e. Supply increases
 Supply curve shifts right /
down
Q
Other options
C) A news report that coffee consumption greatly
increases productivity.
 Demand Increases
D) An increase in the price of tea.
 Quantity demanded for TEA drops
 Tea & Coffee: Substitutes
 Coffee Demand increases
E) An increase in the coffee drinking population.
 More consumers coming into market NOT
because of price changes
 Demand increases
Q6 What might cause Demand to shift from the
Original Demand to the New Demand?
e ofprice
a cup of coffee
A) An expectation that
coffee prices will fall in
the future.
New Supply B) An increase in the price
of coffee creamer.
C) A decrease in the price
of tea.
D) A report that coffee is
bad for your health.
E) An increase in income.
Original Supply
$3.50
3.00
2.50
2.00
1.50
1.00
New Demand
$ .50
0
Original Demand
10 20 30 40
50
60 70
Ans: e
Cups sold in an hour
Factors that shifts Demand CURVE
•
•
•
•
•
•
Income
Preferences
Price of Substitutes
Price of Complements
Population of Potential Buyers
Price EXPECTATIONS
A) An expectation that coffee prices will
fall in the future.
What will happen TODAY?
 At each & every market price,
quantity demanded DROPS
P
 i.e. Demand decreases
D1
D2
 Demand curve shifts left or down.
Q
B) An increase in the price of
coffee creamer
 Qd (creamer) Drops
 coffee creamer + coffee
 complements
P
D1
D2
Q
At each & every market
price, quantity
demanded for coffee
DROPS
i.e. Demand decreases
Demand curve shifts left
or down
C) A decrease in the price of tea.
 Qd (Tea) increases
 Tea , coffee
 Substitutes
P
D1
D2
Q
At each & every market
price, quantity
demanded for coffee
DROPS
i.e. Demand decreases
Demand curve shifts left
or down
D) A report that coffee is bad for
your health.
 potential buyers drops
P
D1
D2
Q
At each & every market
price, quantity
demanded for coffee
DROPS
i.e. Demand decreases
Demand curve shifts left
or down
E) An increase in income
P
At each & every market
price, quantity
demanded for coffee
increases
i.e. Demand increases
Demand curve shifts
right or up
D2
D1
Q
Q8 Suppose the coffee lobby convinced the legislature to
impose last year a price control requiring that coffee
prices must be at least $2.50 when the original demand
function and supply function were applicable. The most
likely result with the new demand and supply would be
A) a short term excess demand for coffee, followed by an increase in
price.
B) a short term excess supply of coffee, followed by a decrease in
price.
C) excess demand for coffee that would not correct itself because
price is set by law.
D) excess supply of coffee that would not correct itself because price
is set by law.
E) new equilibrium at a price of $2.50 and a quantity of 50 cups.
Ans: d
Q8
I) fixed price at $2.5
II) original demand & Supply cruves
ceprice
of a cup of coffee
Red Arrow:
Excess supply
 Price floor
New Supply
 min price set by
external forces
(lobby)
 can price freely go
back to equilibrium?
New Demand
Original Supply
$3.50
3.00
2.50
2.00
1.50
1.00
$ .50
0
Original Demand
10 20 30 40
50
60 70
Cups sold in an hour
Q9 Assume that column A and column B are
demand and supply curves. The market would
achieve an equilibrium at a price of
A)
B)
C)
D)
E)
$20.
$30.
$40.
$50.
$60.
Ans: c
Price/ Unit
$20
$30
$40
$50
$60
Column A
Units/year
100
85
70
55
40
Column B
Units/ year
50
60
70
80
90
•
•
If $20:
Qd>Qs
excess demand
If $60
Os>Qd
Excess Supply
Will ONLY happen
when there’s some
external forces that
prevent market price
from moving towards
the market equilibrium.
Price/ Unit
$20
$30
$40
$50
$60
Column A
Units/year
100
85
70
55
40
Column B
Units/ year
50
60
70
80
90
Q10 One observes that the equilibrium price of
apples falls and the equilibrium quantity
increases. Which of the following best fits the
observed data?
A) An increase in demand with supply constant
B) A decrease in supply with demand constant
C) An increase in demand coupled with an
increase in supply
D) A decrease in demand with supply constant
E) Demand constant and an increase in supply
Ans: e
A) An increase in demand with
supply constant
P
D2
S
D1
P2
P1
Q
Q1
Q2
B) A decrease in supply with
demand constant
P
D1
S2
S1
P2
P1
Q
Q2 Q1
D) A decrease in demand with
supply constant
P
D1
S
D2
P1
P2
Q
Q2
Q1
E) Demand constant and an
increase in supply
P
D1
S1
S2
P1
P2
Q
Q1 Q2
C) An decrease in demand coupled with an
decrease in supply
Case I
P
D1
S2
D2
S1
P2
P1
Q
Q2
Q1
C) An decrease in demand coupled with an
decrease in supply
Case II
P
D1
D2
S2
S1
P1
P2
Q
Q2
Q1
What if
An increase in demand coupled with
an increase in supply?
Case I
P
D2
S1
D1
S2
P1
P2
Q
Q1
Q2
What if
An increase in demand coupled with
an increase in supply?
Case II
P
D2
S1
D1
S2
P2
P1
Q
Q1
Q2