Chapter 2
MARKET TRANSACTIONS: DEMAND AND SUPPLY ANALYSIS
The Chapter in a Nutshell
1. A market is a mechanism through which buyers and sellers communicate to trade goods and
services. Through the price system, markets link potential buyers to potential sellers.
2. Demand is a schedule that shows various amounts of a good or service buyers are willing and
able to purchase at each possible price during a particular period. A demand curve is a
graphical portrayal of the data comprised by a demand schedule. A movement along a
demand curve, resulting from a change in price, is called a change in quantity demanded.
3. According to the law of demand, price and quantity demanded are inversely related, assuming
the other factors affecting the quantity demanded remain the same. Economists explain the
law of demand in terms of the substitution effect, the income effect, and the principle of
diminishing marginal utility.
4. A demand shifter is a variable that causes a shift in a demand curve. Among the most
important demand shifters are consumer tastes, number of buyers, consumer income, prices
of related goods, and expected future prices. When a demand shifter causes an increase in
demand, the demand curve shifts rightward; a decrease in demand is shown by a leftward
shift in the demand curve.
5. Supply is a schedule or curve showing the amounts of a good or service that firms or
households are willing and able to sell at various prices during a specified period. The
quantity supplied refers to a single point on a supply curve. Changes in quantity supplied are
caused by changes in the price of the product.
6. According to the law of supply, sellers are willing and able to make available more of their
product at a higher price than a lower price, other determinants of supply being constant. The
tendency for the cost of additional output to increase explains the law of supply.
7. A supply shifter is a variable that causes a shift in a supply curve. Among the major supply
shifters are resource prices, technology, prices of other goods, expected future prices, taxes
and subsidies, and the number of suppliers. When a supply shifter results in an increase in
supply, the supply curve shifts rightward; a decrease in supply is shown as a leftward shift in
the supply curve.
8. In a competitive market, equilibrium occurs when the price of a product adjusts so that the
quantity that consumers will purchase at that price is identical to the quantity that suppliers
will sell. The price that sets buyers’ intentions equal to sellers’ intentions is called the
equilibrium price. A surplus of a product results in price falling to its equilibrium level; a
shortage of a product results in price rising to its equilibrium level.
10
Chapter 2: Market Transactions: Demand and Supply Analysis 11
9. Concerning shifts in the demand curve or supply curve, we can make the following
predictions, other factors remaining constant:
When demand increases, both the equilibrium price and the equilibrium quantity increase.
When demand decreases, both the equilibrium price and the equilibrium quantity decrease.
When supply increases, equilibrium price falls and equilibrium quantity rises.
When supply decreases, equilibrium price rises and equilibrium quantity falls.
Chapter Objectives
After reading this chapter, you should be able to:
1. Identify the major factors affecting demand.
2. Identify the major factors affecting supply.
3. Explain how prices and quantities are determined in competitive markets.
4. Explain why prices sometimes decrease, and sometimes increase.
5. Predict how prices and quantities will respond to changes in demand or supply.
Knowledge Check
Key Concept Quiz
1. substitution effect
2. income effect
3. diminishing marginal utility
4. change in demand
5. change in quantity supplied
6. normal good
7. complementary good
8. market equilibrium
9. surplus
10. shortage
11. law of demand
12. law of supply
_____ a. price and quantity demanded are negatively related
_____ b. when quantity supplied exceeds quantity
demanded
_____ c. consumers substitute the cheaper good
_____ d. price and quantity supplied are positively related
_____ e. consumers experience a decline in the purchasing
power of their income when price increases
_____ f. is caused by a change in price
_____ g. when quantity supplied equals quantity demanded
_____ h. each additional unit provides less and less utility
_____ i. goods that go together
_____ j. when quantity demanded exceeds quantity
supplied
_____ k. something you buy more of when income
increases
_____ l. a change in the demand schedule
12 Chapter 2: Market Transactions: Demand and Supply Analysis
Multiple Choice Questions
1. The law of demand states that
a.
b.
c.
d.
price and quantity demanded have a positive relationship
price and quantity demanded have no relationship
price and quantity demanded have a negative relationship
when price increases, quantity demanded also increases
2. If the price of computers decreases,
a.
b.
c.
d.
the demand for compatible software increases
the demand for compatible software decreases
the demand for computers increases
there is no effect in the market for computers
3. If used cars are inferior goods and incomes decline
a.
b.
c.
d.
sales of new cars remain unchanged
sales of used cars decline
sales of new cars increase
sales of used cars increase
4. If Burger King lowers the price of its hamburgers
a.
b.
c.
d.
demand for McDonald hamburgers increases
demand for Burger King hamburgers increases
demand for McDonald hamburgers decreases
demand for Burger King hamburgers decreases
5. In voting for subsidies to dairy farmers, a legislator is
a.
b.
c.
d.
helping to decrease the supply of dairy products
helping to increase the supply of dairy products
wasting taxpayer dollars
helping allocate resources efficiently
6. If the supply of good X increases and the demand for good X remains the same
a.
b.
c.
d.
the equilibrium price rises
the equilibrium quantity decreases
the equilibrium price remains unchanged
the supply curve shifts to the right
7. When the demand for computers increases and the salaries in the computer industry also
increase
a.
b.
c.
d.
the equilibrium price and quantity of computers decrease
the equilibrium price of computers increases
the equilibrium quantity of computers increases
the equilibrium quantity of computers decreases
Chapter 2: Market Transactions: Demand and Supply Analysis 13
8. Suppose that the equilibrium price of CD players increases due to an increase in consumer
incomes. If the supply of CD players remains stable
a. equilibrium quantity must increase
b. equilibrium quantity will remain unchanged
c. CD players are inferior goods
d. there is a decrease in the quantity demanded of CD players
9. Due to improvement in productivity, Boeing is able to reduce its production time. At the
same time demand for Boeing airplanes falls due to an economic downturn in Asia. This will
lead to
a.
b.
c.
d.
a decrease in the equilibrium quantity of Boeing airplanes
an increase in the equilibrium quantity of Boeing airplanes
a decrease in the equilibrium price of Boeing airplanes
an increase in the equilibrium price of Boeing airplanes
10. If California orange growers experience labor shortages due to stricter restrictions on
immigrant pickers, while the demand for oranges remains stable
a.
b.
c.
d.
the equilibrium price of oranges will increase
the equilibrium quantity of oranges will increase
the supply of oranges will remain unchanged
the equilibrium price of oranges will remain unchanged
11. When new Internet companies enter existing markets, they help to
a.
b.
c.
d.
increase the demand
increase the supply
decrease the equilibrium quantities
increase the equilibrium prices
12. The supply curve illustrates how
a.
b.
c.
d.
quantity supplied increases as price decreases
quantity supplied increases as price increases
quantity supplied increases as technology improves
quantity supplied increases as resource prices decrease
13. The demand curve for Coca Cola would most likely shift to the left in response to a (an)
a.
b.
c.
d.
decrease in the price of corn nuts which are consumed with Coca Cola
increase in the money income of households
decrease in the price of Coca Cola
decrease in the price of Pepsi Cola
14 Chapter 2: Market Transactions: Demand and Supply Analysis
14. In a free market, the pricing system would ration natural gas to those buyers who
a.
b.
c.
d.
owned the most homes that were heated with furnaces using natural gas
had the greatest amount of income
did the best job of conserving natural gas
were willing and able to pay the highest price
15. When Mary purchases dresses, her gains in satisfaction become smaller as successive dresses
are purchased. Therefore, Mary will purchase additional dresses only if their price declines.
Which of the following applies to this situation
a.
b.
c.
d.
income effect
substitution effect
law of diminishing marginal utility
law of decreasing opportunity costs
16. A producer’s supply curve is upward sloping when
a.
b.
c.
d.
production costs of additional units of output increase
the producer envisions an inverse relationship between price and quantity supplied
the producer realizes decreased profits as output expands
mass production efficiencies take place as output expands
17. The income effect, substitution effect, and law of diminishing marginal utility explain
a.
b.
c.
d.
why the demand curve for a product is downsloping
why the demand curve for a product is upsloping
why the supply curve of a product is downsloping
why the supply curve of a product is upsloping
18. A movement along the demand curve for HP computers will occur in response to
a.
b.
c.
d.
a change in buyer income
a change in the price of HP computers
a change in the price of Gateway computers
buyer expectations of changing future prices of HP computers
19. The production of additional barrels of oil tends to entail
a.
b.
c.
d.
increasing costs
constant costs
decreasing costs
zero costs
20. If the demand for coal increases more than the supply of coal, we would expect
a.
b.
c.
d.
a decrease in market quantity and a decrease in price
a decrease in market quantity and an increase in price
an increase in market quantity and a decrease in price
an increase in market quantity and an increase in price
Chapter 2: Market Transactions: Demand and Supply Analysis 15
21. Rush-hour congestion on the highways of large cities could be reduced by all of the
following except
a.
b.
c.
d.
building additional highways
encouraging people to travel on buses or subways
assessing drivers tolls during peak driving periods of the day
decreasing the cost of a driver’s license
True-False Questions
1.
T
F
Change in quantity demanded and change in demand are identical
concepts.
2.
T
F
The principle of diminishing marginal utility implies that total
satisfaction declines when more of a good is consumed.
3.
T
F
When a good is inferior and income decreases, we buy more of the good.
4.
T
F
Future prices have no effect on quantity demanded.
5.
T
F
When the price changes, the demand changes as well.
6.
T
F
If the price of a substitute in production changes, the supply curve shifts.
7.
T
F
A decline in resource prices and a tax cut have similar effects on supply.
8.
T
F
A shortage causes prices to decline.
9.
T
F
If demand decreases while supply remains stable, a temporary surplus
ensues.
10.
T
F
When both supply and demand change simultaneously, it is not possible
to determine the direction of change for both equilibrium price and
quantity.
11.
T
F
When there is excess supply in the market, prices will tend to move
down.
12.
T
F
If people take more vacations when incomes increase, vacations are
normal goods.
13.
T
F
Other things remaining constant, if the demand for Coca-Cola decreases
due to a health scare in Europe, the equilibrium price of Coca-Cola also
decreases.
14.
T
F
If the productivity of the U.S. worker improves in the software industry,
the equilibrium price of software will increase.
15.
T
F
Prices react to shortages and surplus and move the market back to
equilibrium.
16.
T
F
A tax on cigarettes reduces the demand for cigarettes.
17.
T
F
A subsidy placed on the production of steel lowers the price of steel.
18.
T
F
An increase in the demand for software engineers increases the supply of
software engineers.
16 Chapter 2: Market Transactions: Demand and Supply Analysis
19.
T
F
Other things remaining the same, a decrease in the annual fees charged
by credit card companies would increase the demand for credit cards.
20.
T
F
A decrease in the price of steel would increase the supply of
automobiles.
21.
T
F
Compared to motorists in many European countries, American motorists
tend to pay higher taxes for each gallon of gas.
22.
T
F
Economic theory predicts that at least part of the current nursing shortage
would be eliminated if wages were increased for nurses.
23.
T
F
If the demand curve for wheat decreases more than the supply curve of
wheat, the price of wheat will rise while equilibrium quantity will
decrease.
24.
T
F
The production of oil tends to be consistent with the law of supply.
25.
T
F
An increase in the price of beans will cause the supply curve of beans to
shift rightward.
26.
T
F
The income effect and substitution effect explain why the supply curve
of wheat is upsloping.
27.
T
F
A market is a mechanism through which buyers and sellers communicate
to trade goods and services.
28.
T
F
An increase in demand suggests that a buyer is willing and able to
purchase a larger quantity at a particular price.
Application Questions
_________________________________
Price
Quantity
Demanded
Quantity
Supplied
____________________________________
$100
1000
200
$200
800
400
$300
600
600
$400
400
800
$500
200
1000
_________________________________
1. The table above describes the market for VCRs.
a. Plot the demand and supply schedules. What is the equilibrium price? The equilibrium
quantity?
Chapter 2: Market Transactions: Demand and Supply Analysis 17
b. At the price of $200, what is the quantity demanded? What is the quantity supplied?
Will price tend to increase?
c. At the price of $400, what is the quantity demanded? What is the quantity supplied?
Will price tend to decrease?
2. A new product, DVD is introduced into this market and consumers prefer it to VCRs. The
new demand schedule for VCRs is represented in the following table.
_______________________________
Quantity Demanded
Price
of VCRs
_______________________________
$100
800
$200
600
$300
400
$400
200
$500
0
_______________________________
a. Plot the new demand schedule. What is the direction of the shift in the demand curve?
b. What is the new equilibrium price and quantity?
c. Is there an excess demand or excess supply at the old equilibrium price?
3. Now the VCR producers organize and are able to secure a subsidy for production. What will
happen to the supply schedule? Will this new equilibrium quantity and price be more or less
than the answer to question 2a?
18 Chapter 2: Market Transactions: Demand and Supply Analysis
Answers to Knowledge Check Questions
Key Concept Answers
1.
c
7.
i
2.
e
8.
g
3.
h
9.
b
4.
l
10. j
5.
f
11. a
6.
k
12. d
Multiple Choice Answers
1.
c
5.
b
2.
d
6.
d
3.
c
7.
b
4.
c
8.
a
9.
10.
11.
12.
c
a
b
b
13.
14.
15.
16.
d
d
c
a
17.
18.
19.
20.
a
b
a
d
21. d
True-False Answers
1.
F
6.
T
2.
F
7.
T
3.
T
8.
F
4.
T
9.
T
5.
F
10. T
11. T
12. T
13. T
14. F
15. T
16.
17.
18.
19.
20.
F
T
F
F
T
21.
22.
23.
24.
25.
F
T
F
T
F
26.
27.
28.
Application Question Answers
T
T
T
Chapter 2: Market Transactions: Demand and Supply Analysis 19
1. a. Equilibrium price = $300
Equilibrium quantity = 600 VCRs
b. Quantity demand = 800 VCRs
Quantity supplied = 400 VCRs
Yes, there is a shortage and price will increase.
c. Quantity demanded = 400 VCRs
Quantity supplied = 800 VCRs
Yes, there is a surplus and price will decline.
2. a. The demand curve shifts to the left
b. Equilibrium price = $250
Equilibrium quantity = 500 VCRs
c. There is an excess supply at the old equilibrium price.
3. The supply curve will shift to the right. The equilibrium price will be lower and the quantity
will be higher.