You are on page 1of 18

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

Chapter 02 - Supply and Demand

  • 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

Chapter 02 - Supply and Demand

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

t

Q 1

to

t

Q 2 (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 P 1 1 t P P 1 2 t l P 2 D
Price
Price
S
P
1
1
t
P P 1 2
t
l
P 2
D
Q 2 Q 1
t
t
Tea
S D 1 D 2 Q 1 Q 1 2 1 Lemons
S
D
1
D
2
Q
1
Q
1
2
1
Lemons

2-3

Chapter 02 - Supply and Demand

  • 1. b) The ceiling price for tea lowers the quantity people are able to buy from

t

Q 1

to

t

Q 2 .

There

is excess demand for tea at the ceiling price

t

P 2

, 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

t

P 3

for tea. So the price ceiling

actually raises the opportunity cost of additional units of tea.)

P tea t S t P 3 t P 1 t P 2 D t t
P
tea
t
S
t
P
3
t
P
1
t
P
2
D
t
t
Q
Q
Q
2
1

tea

P coffee c S c P 2 c P 1 D 2 D 1 c c
P
coffee
c
S
c
P
2
c
P
1
D
2
D
1
c
c
Q
Q
Q
coffee
1
2
  • 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

Price

Chapter 02 - Supply and Demand

224

168

112

56

0

D S
D
S

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

Chapter 02 - Supply and Demand

P(toys) S P1 P2 D2 Q2 Q1
P(toys)
S
P1
P2
D2
Q2
Q1

D1

Q(toys)

  • 4. b) Both quantity and price drop because demand shifts to the left.

P(battery) S P1 P2 D2 Q2 Q1
P(battery)
S
P1
P2
D2
Q2
Q1

D1

Q(battery)

  • 4. c) Both price and quantity go up because demand shifts to the right.

Chapter 02 - Supply and Demand P(toys) S P1 P2 D2 Q2 Q1 D1 Q(toys) 4.

2-6

Chapter 02 - Supply and Demand

  • 5. a) The price goes up, the quantity goes down.

P(oil) S2 P2 P1 D Q2 Q1
P(oil)
S2
P2
P1
D
Q2
Q1

S1

Q(oil)

  • 5. b) The price and the quantity go down.

P(air) S P1 P2 D2 Q2 Q1
P(air)
S
P1
P2
D2
Q2
Q1

D1

Q(air)

  • 5. c) The price and the quantity go up.

2-7

Chapter 02 - Supply and Demand

P(rail) S P2 P1 D2 D1 Q(rail) Q1 Q2
P(rail)
S
P2
P1
D2
D1
Q(rail)
Q1
Q2
  • 5. d) The price and the quantity go down.

P(hotel) S P1 P2 D2 Q2 Q1
P(hotel)
S
P1
P2
D2
Q2
Q1

D1

Q(hotel)

  • 5. e) The price goes down, the quantity goes up.

2-8

Chapter 02 - Supply and Demand

P(milk) S1 P1 P2 D Q1 Q2
P(milk)
S1
P1
P2
D
Q1
Q2

S2

Q(milk)

  • 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

Chapter 02 - Supply and Demand

  • 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) 1900 D’ D 100 50 0 80 90 92.5 102.5 105
S
Price (R)
1900
D’
D
100
50
0
80
90
92.5
102.5
105

Quantity of seats per game ('000)

  • 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

Chapter 02 - Supply and Demand

Price (R) 6000 S D D' 4000 3000 0 3000 4000 9000 10000 11000 14000
Price (R)
6000
S
D
D'
4000
3000
0
3000
4000
9000
10000 11000
14000

Quantity (units/month)

  • 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
government R500/ton, so the added expenditure is 500(500) = R250 000.
Price (R)
600
S
500
S’
D
0
100
500
1000

Quantity (tonnes/yr)

2-11

Price (R/kg)

Chapter 02 - Supply and Demand

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

7

6

5

4

3

2

1

0

D S
D
S

0

1

2

3

4

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

Chapter 02 - Supply and Demand

6 S 5 4 3 2 1 D 0 0 1 2 3 4 5 6
6
S
5
4
3
2
1
D
0
0
1
2
3
4
5
6
Price (R/gram)

Quantity (tons)

6 S' S 5 4 3 2 1 D 0 0 1 2 3 4 5
6
S'
S
5
4
3
2
1
D
0
0
1
2
3
4
5
6
Price (R/gram)

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

Chapter 02 - Supply and Demand

  • 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 S’ S 5 3 0 3 8
Price of Titanium (R/gram))
8
S’
S
5
3
0
3
8

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 4 6
Price of Titanium (R)
S'
6
S
4
D
0
2
4
6

2-14

Chapter 02 - Supply and Demand

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 28 21 14 7 D 0 0 7 14 21 28 35 42
42
S
35
28
21
14
7
D
0
0
7
14
21
28
35
42
Price

Quantity

2-15

Price

Chapter 02 - Supply and Demand

42

35

3

28

21

14

7

0

S' D S
S'
D
S

0

7

11

14

21

28

35

42

Quantity

  • 16. a-b) The buyer's share is the increase in price divided by the total tax: t b = 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 t s = 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 Q 1 is imposed, Korean car makers will be able to

charge P 1 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 Q 1 . The result is a price to the South

African buyer of P 1 , 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

Chapter 02 - Supply and Demand

S' Price S P 1 P* P -T 1 D Q* Q 1
S'
Price
S
P
1
P*
P -T
1
D
Q*
Q
1

Quantity

18.

 

120

90

60

45

30

Price

S(tax)

Price S(tax) S D Quantity

S

D

 

Quantity

 

15

30

60

18.

a) Before tax:

120-2Q=30+Q (in equilibrium)

Q = 30

P = 60

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

Chapter 02 - Supply and Demand

  • 18. c) Sellers share = 60 45 = 15

Buyer’s 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.

Price (R)

28

20

16

Supply + tax Supply D 0 4 5 Quantity (units/wk)
Supply + tax
Supply
D
0
4
5
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 D 20 S D' 0 4 8
28
24
D
20
S
D'
0
4
8

Quantity (units/wk)

2-18