Tutorial 3 SUPPLY AND DEMAND: AN INTRODUCTION

Chapter 3
Review Questions
1. Simply knowing the cost of producing a good is not sufficient enough to
predict a market price as the market price is based upon the delicate balance
between the supply and demand of a good. As such, no specific market value
can be determined as there exists no definite market price, due to the ever
shifting demands of the consumers and the necessary supply adjustments by
the sellers.
2. Change in demand refers to the phenomenon where external factors cause
the demand of a product or good to change. The effect of this upon the
demand curve is a shift in the entire curve, either towards the left or right,
depending upon the circumstances. Change in the quantity demanded refers
to either an increase or decrease in the demand for a product, usually relating
to price changes, for example an increased quantity demanded of a product
that has dropped in price. The effect this has upon the demand curve is a
movement along the demand curve, no shift of curve occurs.
3. The horizontal interpretation of the demand curve refers to the reading of the
demand curve starting from a reference point in price and noting the
corresponding quantity demanded for the good at that price.
The demand curve can also be interpreted vertically, in a similar manner.
Starting from a reference quantity, and reading the corresponding price that
buyers are willing to pay for such a quantity, or the buyers reservation price
for the product at that quantity.
4. When a price is below the equilibrium level, the quantity that buyers wish to
purchase exceeds the quantity that sellers are willing to sell, and as such
there is an excess demand for the product. Naturally, frustrated consumers
will try to increase their chances of acquiring more of the product by
increasing the amount they are willing to pay for the good, which
consequently will result in the increase in the quantity of the good as more
and more buyers would be willing to pay more to acquire the good.
When the price is set above the equilibrium price, the quantity that buyers
would be willing to purchase is lower than the quantity that sellers wish to
sell, and as such an excess supply or surplus is produced. This time, it is the
sellers who are frustrated, as their product is not selling to many customers,
and they will likely respond in lowering the price in the hopes that it will
attract more buyers, and thus increase the quantity demanded.
The price, if not already set to the equilibrium price, will tend to naturally shift
towards the equilibrium, and form a steady-state situation, in which both the
buyer and seller are satisfied with the price and quantity of the good sold.

6. When analysing the impacts of situational changes and the corresponding

effects such changes have on the supply and demand curves, economists like
to employ a condition of ceteris paribus, a Latin phrase which means to
keep all other things the same. In the case of economics, the ceteris paribus
condition assumes that all other facets of a model are held constant.
The principle behind the use of ceteris paribus, is to assist in the investigation
of change within economics, and the prediction of how change will affect a
product. This is accomplished by isolating the effect of any one particular
variable of a model from the rest of the model.
The philosophy behind ceteris paribus is crucial as it allows for economists to
change variables one at a time and analyse the consequential impacts of
those individual changes, and conclude the individual effects of individual
changes. On an expanded scale, ceteris paribus allows economists to come to
conclusions about the effects that change in certain fields of economics has
on certain products or goods.
For example, if the price of a good, say eggs, increased, then the quantity of
eggs demanded by buyers will decrease. This model only takes into account
the single variable of the price, and does not account for other changes that
the increase in egg prices may cause. In this example, this leaves us with a
relationship between the price of eggs, and the demand for eggs, which
appears to be inversely proportional.

Problems
1. a) Tennis and squash courts are substitutes of each other, because, as the
price of one of them
increases, the demand for the other will grow.
As the price of tennis court hire increases, more people will opt to play
squash.
b) DVD players are DVDs are complements of one another, as the increase of
price in either good, will result in the decrease in demand for the other. As the
price of DVD players increase, fewer people will buy DVDs.
c) Private and public schools are substitutes of one another, as the increase
in price of one will cause the heightened demand for the other. In this case,
as private schools increase school fees, more parents will enrol their children
into public schools.
d) Disposable and cloth nappies are substitute goods. The increase in price of
either good will increase the demand for the alternate good. If disposable
nappies increase in price, more people will opt for cloth nappies instead, so as
to save money.
2. a) The supply curve would shift to the right, due to the technological
improvement of producing wheat.
b) The supply curve would shift to the left, as increases in fertiliser means
that higher input prices are required for the same amount of wheat output.
c) The supply curve would shift to the right, as the drought relief program
would assist farmers, and allow for more profitability.
d) The supple curve would shift to the left, as a drought would destroy many
crop fields, thus decreasing the supply that farmers could provide.
3. a) The demand curve would shift right, as overseas travel is a normal good,
the demand increases with an increasing income.
b) The demand curve would shift to the left, as the consumer perceptions of
mobile phones would decrease, thus decreasing the demand for the phones.
c) The demand curve would shift to the right, as CDs and MP3s are
substitutes, and the increase in price of MP3s would make the CD alternative
more attractive to more buyers.
d) The demand curve would shift to the left, as CDs are complementary
goods to CD players, an increase in the price of CDs would mean fewer
people would pursue the purchase of CD players.
4. Due to the increase in input costs, as a result of the wage bump, to produce
apples, the supply curve will shift to the left, whilst the demand curve remains
the same. This results in a heightened equilibrium price and a lower
equilibrium quantity.
5. An increase in the birth-rate will cause the demand of child care services to
increase, and thusly, the demand curve would shift to the right to represent
this, whilst the supply curve remains the same. This causes the equilibrium
price to increase along with the equilibrium quantity.
6. The increase in mandatory insurance levels would decrease the popularity of
personal transport, and would thus decrease the demand for cars, shifting the
demand curve to the left. The supply curve remains the same, and as a result,
both the equilibrium price and quantity decrease.

7. As graduation week brings many family and friends wishing to attend the
momentous occasion of their loved ones, the demand of hotel rooms also
increase as the friends and family may wish to stay near the campus for
graduation, especially if they live great distances from the campus. This
increase in the demand shifts the demand curve to the right, while the supply
does not shift, resulting in an increased equilibrium price and quantity.
8. The discovery of the newfound benefits of consuming apples will result in the
increase in demand of apples, shifting the demand curve to the right.
Meanwhile, the sudden drop in available apples due to the apple-tree killing
fungus will restrict the supply of apples, shifting the supply curve to the left.
Supply and demand analysis yields two possible cases in such a model. The
two cases are resultant due to the unknown magnitude of shift of the supply
curve, and the resulting position of the equilibrium. The following diagrams
illustrate the differences between the two cases. Both cases have an
increased equilibrium price, however the equilibrium quantity is higher in
Case 1, and lower in case 2.

9. Changes in lending practices to reduce credit availability for housing

decreases the supply of housing, whilst the demand remains the same. This
shifts the supply curve to the left, and consequently reduces the equilibrium
quantity while at the same time increasing the equilibrium price.