Chapter 02 - Supply and Demand Explained

Chapter 02 - Supply and Demand
Chapter 2 Supply and Demand

Answers to Questions for Review
1. A shortage occurs when, at a given price, quantity demanded exceeds quantity supplied.
Scarcity implies that not everyone can consume as much of a good as he wants. A good can
be scarce without a shortage occurring if the price of the good is set at the market
equilibrium.
2. The supply curve would be a horizontal line where the price equals zero. The demand curve
would be a typical demand curve. If the price is greater than zero, then the market system is
acting to allocate resources; not everyone can have as much as they want.
3. Some examples: Reserved parking places for the senior staff of the university; that may lead
to a shortage of parking spaces for students. Giving seniors priority in university residences
may lead to junior students without boarding.
4. The former implies a shift in the supply curve to the left (or vertically up); the latter a
movement along the supply curve.
5. a. Shift in demand
b. Change in quantity demanded (shift in supply)
c. Change in the quantity demanded (shift in supply)
d. Shift in demand
6. Because consumers prefer to pay a lower price. This will only work until other sellers hear
about her price reduction and follow suit.
2-1
7. The allocative function of price is not important with vertical, or nearly vertical, supply
curves, e.g., land. It implies that the supply is close to constant.
8. For the tax burden to fall mostly on consumers rather than producers (buyers rather than
sellers), you want to find a product (or products) for which the quantity supplied is very
responsive (elastic) to price but quantity demanded is less responsive (inelastic) to price.
Addictive goods like cigarettes and alcohol may fit this description.
9. If a poor person were given R500 000 in cash, it is unlikely he would spend it on a Mercedes,
since he probably has other, more pressing wants. Since the gift Mercedes would fetch less
than the cash gift, most poor persons would choose the cash.
2-2
Answers to Chapter 2 Problems

1. a) The imposition of the ceiling price on tea causes a reduction in the quantity of tea bought,
from Q1t to Q2t (left panel). Because less tea is bought the demand curve for lemons shifts to
the left, resulting in a reduction in both price and quantity of lemons (right panel).
Price
Price
S
P11
P1t
P2t
P2l
D1
Q2t Q1t
D2
Q21 Q11
Tea
2-3
Lemons
1. b) The ceiling price for tea lowers the quantity people are able to buy from Q1t to Q2t . There
is excess demand for tea at the ceiling price P2t , and some of this excess demand spills over
to substitute products such as coffee. The result is that the equilibrium price of coffee rises.
(Note: This result may seem inconsistent with the claim that a fall in the price of a good's
substitute reduces the demand for that good. But this claim refers to a fall in the equilibrium
price of the good, not a price reduction caused by a ceiling. Because of the quantity reduction
caused by the ceiling, tea buyers would be willing to pay P3t for tea. So the price ceiling
actually raises the opportunity cost of additional units of tea.)
Pcoffee
P tea
St
Sc
t
P3
Pt
1
Pt
2
c
P
2
c
P
1
D
t
Q Qt
1
2
D
1
Qc Q c
1
2
Q tea
D2
coffee
2. a) At a price of R150 there will be 18 DVDs traded and at a price of R100 68 DVDs will be
traded in the market. At P = R150, sellers are dissatisfied. At P = R100, buyers are
dissatisfied.
2. b) The supply and demand curves, shown in the diagram, intersect at P = 112; Q = 56
2-4
224
S
Price
168
112
56
D
0
0
28
56
84
112
140
168
Quantity
2. c) Total revenue is (112)(56) = R6 272.
3. a-b) A reduction in the price of hardware would raise demand for software and thus cause
equilibrium price and quantity of software to rise. On the other hand, a rise in the price of
software would reduce demand for hardware and thus cause the equilibrium price and
quantity of hardware to fall.
4. a) Both price and quantity drop because demand shifts to the left.
2-5
P(toys)
S
P1
P2
D1
D2
Q2
Q(toys)
Q1
4. b) Both quantity and price drop because demand shifts to the left.
P(battery )
S
P1
P2
D1
D2
Q2
Q(battery )
Q1
4. c) Both price and quantity go up because demand shifts to the right.
2-6
5. a) The price goes up, the quantity goes down.
P(oil)
S2
S1
P2
P1
D
Q(oil)
Q2
Q1
5. b) The price and the quantity go down.
P(air)
S
P1
P2
D1
D2
Q2
Q1
5. c) The price and the quantity go up.
2-7
Q(air)
P(rail)
S
P2
P1
D2
D1
Q1
Q(rail)
Q2
5. d) The price and the quantity go down.
P(hotel)
S
P1
P2
D1
D2
Q2
Q1
5. e) The price goes down, the quantity goes up.
2-8
Q(hotel)
P(milk)
S1
S2
P1
P2
D
Q(milk)
Q1
Q2
6. a) In quantity demanded.
6. b) In demand.
6. c) In demand.
6. d) In demand.
6. e) In quantity demanded.
7.
a) The equilibrium quantity is Q = 90 000 seats and the equilibrium price is P = 1900
(1/50)(90 000) = 1 900 1 800 = R100.
7.
b) At a price ceiling of P = R50, quantity demanded is found by solving 50 = 1900 (1/50)Q

for Q = 92 500 seats. Since the stadium only holds Q = 90 000 seats, there will be 92 500
90 000 = 2 500 dissatisfied fans who want to buy a ticket at P = R50 but cannot find one
available.
7. c) Quantiy demanded for the higher demand is found by solving 50 = 2100 (1/50)Q for
Q = 102 500 seats. Now there will be 102 500 90 000 = 12 500 dissatisfied fans who want
to buy a ticket at P = R50 but cannot find one available. The excess demand is
12 500 2 500 = 10 000 seats more than for the not so big game.
2-9
7. d) Normally a price ceiling both raises quantity demanded and lowers quantity supplied.
Here, only the first effect is present because the stadium capacity is fixed.
(Graph not drawn according to scale.)
S
Price (R)
D
1900
D
100
50
0
80
90
92.5
Quantity of seats per game ('000)
102.5
105
8. a) With the initial demand and supply curves equilibrium is at a price of R6 000/month and 6
000 apartments. Under the original demand curve, quantity demanded was Q = 9 000 units (3
000 = 12 000 Q) and quantity supplied Q = 3 000 units (3 000 = Q), so excess demand was
9 000 3 000 = 6 000 units. With the larger demand, quantity demanded becomes
Q = 11 000 units (3 000 = 14 000 Q) and quantity supplied is still 3 000, so excess demand
becomes 11 000 3 000 = 8 000 units. Excess demand has grown by 8 000 6 000 = 2 000
units.
8. b) Quantity demanded is Q = 14 000 P; quantity supplied is Q = P. Subtracting quantity
supplied form quantity demanded gives excess demand of 14 000 2P units. Set excess
demand equal to the original level of 6 000 and solve 6 000 = 14 000 2P for the required
price floor of P = R4 000. If the government accommodates the increase in demand by raising
the rent control form R3 000 to R4 000, the degree of excess demand will be unchanged.
2-10
Price (R)
6000
S
D'
4000
3000
3000 4000
9000
Quantity (units/month)
10000 11000
14000
9. a) The normal demand and supply schedules lead to an equilibrium of 300 tonnes at a price of
R300 per ton. With a price support of P = R500/ton and the original supply of P = Q, quantity
supplied must be Q = P = 500 tonnes. Meanwhile, quantity demanded is Q = 100 tonnes, so
excess supply is 500 100 = 400 tonnes. With the expanded supply of P = (1/2)Q, quanity
supplied grows to Q = 2P = 1 000 tonnes. Quanity demanded is still Q = 100 tonnes, so
excess supply grows to 1000 100 = 900 tonnes.
9. b) The extra 900 400 = 500 tonnes the govenrment has to buy of excess supply costs the
government R500/ton, so the added expenditure is 500(500) = R250 000.
Price (R)
600
S
500
S
D
0
100
500
Quantity (tonnes/yr)
2-11
1000
10. The supply curve becomes P = 2 + 2Q and the demand remains P = 8 2Q. By setting the
two equations equal to each other and solving for Q we have Q = 1.5. Substituting 1.5 into
the demand equation results in a price of 5. Alternatively the supply curve can be shifted up
by R2. That means it will intercect the y-axis at R2 and the demand curve at a price of R5 and
a quantity of 1.5 tons.
8
S
7
Price (R/kg)
6
5
4
3
2
1
D
0
0
Quantity (kg/day)
11. The supply curve after the tax is shown as S' in the diagram. The new equilibrium quantity
will fall to 2. The equilibrium price paid by the buyers is now R4/gram. The price received
by the sellers is now R2/gram.
2-12
6
S
Price (R/gram)
1
D
0
0
Quantity (tons)
6
S'
S
Price (R/gram)
0
0
Quantity (tons)
12 The supply curve tells us that at a quantity of 2 tonnes/yr, suppliers will be willing to supply
additional titanium at a price of R2/gram. At that same quantity, buyers are willing to pay
R4/gram. Suppose a supplier sells one gram to a new buyer at a price of R3. This will make
the supplier better off by R1. The buyer will also be better off by R1.
2-13
13 With the tax of T = R2/gram on sellers, the supply curve shifts up by the amount of the tax
from P = Q to P = 2 + Q. The intersection of the tax-ridden supply curve and the new
demand curve is found by solving 8 Q = 2 + Q for Q = 3 tonnes. Inserting the quantity into
the demand curve yields a price buyers pay of P = 8 3 = R5/gram and hence a price sellers
receive of P = 5 2 = R3/gram. The government collects revenue of R2/gram and because 3
tonnes are traded TR = 2(3 000 000) = R6 000 000. Prior to the increase in demand, the
government collected the tax on only 2 tonnes, so its total revenue collected was R4 000 000.
Thus, government revenue has grown by R2 000 000 due to the expansion in demand for
titanium. See the graph below
Price of Titanium (R/gram))

8
5
3
0
3
Quantity of Titanium (tonnes)
14. At a price floor of P = R4/gram, quantity supplied would be Q = 2 tonnes. Using demand
P = 6 Q and P = R4/gram, quantity demanded is also Q = 2 tonnes. Thus, the reduction in
supply raises the equilibrium price to the level of the price floor, so the price floor is no
longer binding.
Price of Titanium (R)

S'
6
S
4
D
0
2-14
Quantity of Titanium (tonnes)
15. a) The effect of the tax is to shift the supply curve upwards by R9 as shown in the diagram at
15(e). The quantity sold falls from 14 to 11 units.
15. b) The new market price is 31. That is what buyers have to pay, but the seller gets to keep
only 22.
15. c)Buyers now spend 11(31)=341.
15 d)The government collects 11(9) = 99.
15. e)
42
S
35
Price
28
21
14
7
D
0
0
14
21
Quantity
2-15
28
35
42
42
S'
35
3
Price
28
21
14
0
0
11
14
21
28
35
42
Quantity
16. a-b) The buyer's share is the increase in price divided by the total tax: tb = 3/9=1/3. Because
the buyer pays R3 of the R9 levied per DVD-pack the seller pays the other R6. The seller's
share is thus ts = 6/9=2/3.
17. In the diagram below, P* and Q* are the original equilibrium price and quantity of Korean
cars sold South Africa. If a quota of Q1 is imposed, Korean car makers will be able to
charge P1 for their cars. To get the same quantity reduction by means of a tax, the after tax
supply curve must intersect the demand curve at Q1 . The result is a price to the South
African buyer of P1, the same as in the quota case. The difference in the two policies is that
in the quota case the price increase goes to Korean car makers, while in the tariff case it goes
to the South African government. The latter policy will make more sense from a South
African perspective.
2-16
S'
Price
P
1
P*
P -T
1
D
Quantity
Q*
Q1
18.
Price
S(tax)
S
120
90
60
45
30
D
Quantity
15
30
60
18. a) Before tax: 120-2Q=30+Q (in equilibrium)
18. b) After tax supply curve: P = 60 + 2Q

Equilibrium: 120 - 2Q = 60 + 2Q
Q = 15
Price, including tax = 90
Price received by seller (net of tax) = 45.
2-17
Q = 30
P = 60
18. c) Sellers share = 60 45 = 15
Buyers share = 90 60 = 30
19. a-c) With the tax on sellers, supply rises by the amount of the tax to P = 4 + 4Q. the
equilibrium is found by solving 20 = 4 + 4Q for Q = 4 units. Buyers pay P = R20 and sellers
receive 20 4 = R16. Sellers pay the full tax because demand is perfectly elastic, which
means that buyers cannot be forced to pay any of the tax.
Supply + tax
Supply
Price (R) 28
20
16
Quantity (units/wk)
20. a-c) With the tax on buyers, demand falls by the amount of the tax to P = 24 Q. The
equilibrium is found by solving 20 = 24 Q for Q = 4 units. Sellers receive P = R20, and
buyers pay 20 + 4 = R24. Buyers pay the full tax because supply is perfectly elastic, which
means that sellers cannot be forced to pay any of the tax.
Price (R)
28
24
20
S
D'
4
Quantity (units/wk)
2-18

Chapter 02 - Supply and Demand Explained

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Chapter 02 - Supply and Demand

Chapter 2 Supply and Demand