Demand, supply and price determination
Key terms
Define each term.
Multiple choice
Circle the correct answer.
The government raises income tax, reducing household disposable income. What happens in the market for restaurant meals, a normal good?
Worked problems
Show your working.
Finding equilibrium and disequilibrium from a schedule. The weekly market for a snack is shown below. Price $1.00: quantity demanded 900, quantity supplied 300. Price $1.50: quantity demanded 700, quantity supplied 500. Price $2.00: quantity demanded 600, quantity supplied 600. Price $2.50: quantity demanded 500, quantity supplied 700. Find the equilibrium, then describe the market at $1.50 and at $2.50.
Diagrams
Show the effect on the market for wheat of a government subsidy paid to farmers.
Answers
Demand: The quantity of a good consumers are willing and able to buy at a given price over a given period.
Supply: The quantity of a good producers are willing and able to sell at a given price over a given period.
Equilibrium price: The price at which quantity demanded equals quantity supplied, so there is no tendency to change.
B. Income is not the price of the good, so the whole demand curve shifts. Lower income reduces demand for a normal good, moving the curve left. Equilibrium price and quantity both fall.
Step 1. Equilibrium. Quantity demanded equals quantity supplied at $2.00, where both are 600. That is the equilibrium price and quantity.
Step 2. At $1.50. 700 are demanded but only 500 supplied, a shortage of 200. Buyers compete for the limited supply, so the price is pushed up towards $2.00.
Step 3. At $2.50. 500 are demanded but 700 supplied, a surplus of 200. Sellers cannot sell all their stock, so they cut the price towards $2.00.
Step 4. What changes along the way. As the price rises from $1.50 to $2.00, quantity demanded contracts from 700 to 600 and quantity supplied extends from 500 to 600. These are movements along the curves, not shifts.
Always say which is larger, demand or supply, and name the result as a shortage or a surplus. Reading the table is one mark; naming and explaining the disequilibrium is the other.
Supply shifts right. Mark both the original and new equilibrium, label the axes, and show the direction of change in price and quantity.