The supply-and-demand framework is the most powerful framework in the economist’s toolkit. Armed with an understanding of this framework, you can make sense of much economic news, and you can make intelligent predictions about future changes in prices.
A true understanding of this framework is more than just an ability to shift curves around, however. It is an understanding of how markets and prices are one of the main ways in which the world is interlinked. Markets are, quite simply, at the heart of economic life. Markets are the means by which suppliers and demanders of goods and services can meet and exchange their wares. Because exchange creates value—it makes both buyers and sellers better off—markets are the means by which our economy can prosper. Markets are the means by which economic activity is coordinated in our economy, allowing us to specialize in what we do best and buy other goods and services.
Economists wax lyrical about these features of markets, but this should not blind us to the fact that markets can go wrong. There are many ways in which market outcomes may not be the most desirable or efficient. In other chapters, we look in considerable detail at all the ways that markets can fail us as well as help us.
Fill in the missing values in Table 8.7.1 "Individual and Market Demand". What can you say about the missing price in the table?
Price of Chocolate Bars ($) Household 1 Demand Household 2 Demand Market Demand 1 7 22 2 11 16 10 0.5 3 3.5 0.75 4 4.75
- If the income levels of all households increase, what happens to the individual demand curves? What happens to market demand?
- Suppose the price of coffee increases. Household 1 always eats chocolate bars while drinking coffee. What will happen to household 1’s demand for chocolate bars when the price of coffee increases? Household 2 either has coffee or a chocolate bar for dessert. What happens to household 2’s demand for chocolate bars when the price of coffee increases? What happens to the market demand for chocolate bars when the price of coffee increases?
- In Figure 8.2.4 "Market Supply", list the factors that would imply that firm 1 produces fewer chocolate bars than firm 2 when the price is $5. The figure is drawn so that firm 1 produces less than firm 2 at all prices. Does this have to be the case? Could the firms’ supply curves cross?
- (Advanced) Draw a version of Figure 8.6.3 "Shifts in Demand and Marginal Revenue" if there is an outward shift in demand but no shift in marginal revenue. What would happen to the market price?
- Consider the operation of a café. Describe the types of trades in terms of whether they are B2C or B2B. In what ways do you think that B2B trades are different from B2C trades?
- Economists often say that individual decisions are “made at the margin.” How do you see that in the determination of market supply and market demand?
- If there are fewer sellers in a market, what will happen to total output? What will happen to the output of each seller?
- Explain why an increase in the mortgage rate, which reduces the demand for new houses, can teach researchers about the elasticity of the supply curve.
- (Advanced) Using the credit market, show how governmental borrowing increases interest rates. Could governmental borrowing also lead to an outward shift in the supply of credit as households save more to pay off the future debt? How would you show this in a supply-and-demand diagram?
- If the US Federal Reserve Bank takes actions to lower interest rates in the United States relative to other countries, what will happen to the euro price of the dollar? Explain.
- Draw a figure showing an outward shift in a demand curve along with a reduction in marginal revenue. Explain what is going on in the diagram and how a monopolist would respond to the situation.
- Using a spreadsheet, construct a version of Table 8.2.2 "Market Equilibrium: An Example" assuming that market demand = 50 − 5 × price. Fill in all the prices from 1 to 100. What is the equilibrium price and the equilibrium quantity in the market? How would you explain the difference between this equilibrium and the one displayed in Table 8.2.2 "Market Equilibrium: An Example"?
- Find a newspaper article that describes a price change for a good or service. Why did the price change? What happened to the quantities produced and sold?