“Economics”
by Mankiw and Taylor
💓 QUESTIONS for REVIEW 💓
All answered Ch. 3-14; 20-24; 30-33
for the final exam of the course
‘Economics, Markets & Organisations 1’
in Politics, Psychology, Law & Econ (PPLE)
March 30, 2017
,Economics, Markets & Organisations I “Economics” (Mankiw & Taylor)
Questions for Review answered (Tahrim Ramdjan), version for Final Exam
Topic: Supply and Demand. Chapters 3 to 6
3 The market forces of supply and demand
1. What is a competitive market? Briefly describe the types of markets other than
perfectly competitive markets.
- A competitive market is a market in which there are many buyers and sellers. No
one can impact the market price directly.
- The products are homogenous, so a seller has less reason to charge a price other
than the going market price.
- Other forms of markets include:
1. Monopoly: in which only one seller is active that sets the price
2. Oligopoly: in which a few sellers are active that do not necessarily compete in an
aggressive way
3. Monopolistic competition: in which many sellers are active, that all offer slightly
different products (these are heterogeneous) [à pp.42-43]
2. What determines the quantity of a good that buyers demand?
- Many factors can determine the quantity demanded, but the most important is the
price of the concerning good. Quantity demanded falls as price rises, but rises as
price falls. [à p.43]
3. What are the demand schedule and the demand curve, and how are they
related? Why does the demand curve slope downwards?
- The demand schedule shows the relationship between the price of a good and the
quantity demanded.
- The numbers of this table can be shown graphically in the demand curve, in which
the price is on the vertical axis and the quantity demanded on the horizontal axis.
- The demand curve slopes downwards because of the inverse relation between price
and demand (see question 2). [à p. 43-46]
4. Does a change in consumers’ tastes lead to a movement along the demand
curve or a shift in the demand curve? Does a change in price lead to a
movement along the demand curve or a shift in the demand curve?
- The change in consumers’ tastes, as well as any other factors, leads to a shift in the
demand curve.
- The change in price always leads to a movement along the demand curve. [à p. 46]
5. Francine’s income declines and, as a result, she buys more cabbage. Are
cabbages an inferior or a normal good? What happens to Francine’s demand
curve for cabbages?
- Cabbage is an inferior good, because the quantity demanded rises when income
falls. For inferior goods, an increase in income leads to a fall in quantity demanded
and vice versa.
- Francine’s demand curve for cabbages will shift to the right, because of an increase
in quantity demanded due to a factor different than price change. [à p. 46; 48]
6. What determines the quantity of a good that sellers supply?
- There are several determinants, but the most important determinant is the price of
the good. [à p. 50]
2
,Economics, Markets & Organisations I “Economics” (Mankiw & Taylor)
Questions for Review answered (Tahrim Ramdjan), version for Final Exam
Topic: Supply and Demand. Chapters 3 to 6
7. What are the supply schedule and the supply curve, and how are they related?
Why does the supply curve slope upwards?
- The supply schedule shows the relationship between the price of the good and the
quantity supplied. The supply curve displays this relationship graphically.
- The supply curve slopes upwards, because the quantity supplied rises as price
increases.
- The logic behind this is that if the price is high, the business is more profitable so a
bigger quantity supplied can be offered. [à p. 50]
8. Does a change in producers’ technology lead to a movement along the supply
curve or a shift in the supply curve? Does a change in price lead to a
movement along the supply curve or a shift in the supply curve?
- Again, as for the demand curve, a change in producers’ technology and any factor
other than a mutation in price of the good, leads to a shift of the supply curve.
- A change in price leads to a movement along the supply curve. [à p. 53]
9. Define the equilibrium of a market. Describe the forces that move a market
toward its equilibrium.
- The market forces that move a market to its equilibrium are supply and demand.
- At the equilibrium, the amount that consumers are wishing to buy for a particular
price (demand) is equal to the amount that suppliers are willing to produce and
sale for that price (supply).
- The equilibrium price can also be called the market-clearing price. [à p. 57]
10. Describe the role of prices in market economies.
- Prices can signal to buyers what amount of money they have to give up to receive
the utility of consuming the good.
- To sellers, prices signal the profitability of production. A higher price is required for
additional cost and increasing profit.
- If prices rise in a free market, this means to a seller that there is a shortage and that
he has to expand production. For buyers, it means that they have to give more up to
get the good and that they have to decide whether the extra price is worth it. [à p. 58-59]
4 Elasticity and its applications
1. Define the price elasticity of demand and the income elasticity of demand.
- The price elasticity of demand measures to what extent the quantity demanded
responds to a change in price. [à p.75]
(𝑄2 − 𝑄1)
( )
(𝑄2 + 𝑄1)
𝑃𝑟𝑖𝑐𝑒 𝑒𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦 𝑜𝑓 𝑑𝑒𝑚𝑎𝑛𝑑 (𝒎𝒊𝒅𝒑𝒐𝒊𝒏𝒕 𝒇𝒐𝒓𝒎𝒖𝒍𝒂) = 2
𝑃2 − 𝑃1
( )
(𝑃2 + 𝑃1)
2
- The income elasticity of demand measures to what extent the quantity demanded
changes as consumer income changes.
𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑𝑒𝑑
𝐼𝑛𝑐𝑜𝑚𝑒 𝑒𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦 𝑜𝑓 𝑑𝑒𝑚𝑎𝑛𝑑 =
𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑖𝑛𝑐𝑜𝑚𝑒
3
,Economics, Markets & Organisations I “Economics” (Mankiw & Taylor)
Questions for Review answered (Tahrim Ramdjan), version for Final Exam
Topic: Supply and Demand. Chapters 3 to 6
2. List and explain some of the determinants of the price elasticity of demand.
Think of some examples to use to illustrate the factors you cover.
- The availability of close substitutes. Goods with close substitutes have more elastic
demand, because it is easier for consumers to switch to other goods. Exemplary:
butter and margarine.
- Necessities versus luxuries. Necessities (e.g. electricity, gas) have relatively
inelastic demands, but luxuries (e.g. perfume) do have elastic demands.
- Definition of the market. If markets are narrowly defined, then goods are more
elastic; it is easier to find close substitutes. E.g. food is broad defined and it is hard to
find a substitute for food, but if you narrowly define food as e.g. chocolate, it is easier
to find substitutes.
- Proportion of income, devoted to the product. The greater the proportion of income
a product needs, the greater the price elasticity is likely to be.
- Time horizon. Goods tend to have more elastic demand over longer time. Example:
petrol: when price rises; demand will react only slightly, but on the long-term people
might take public transport instead of their car. [à p.73]
3. If the elasticity is greater than 1, is demand elastic or inelastic? If the elasticity
equals 0, is demand perfectly elastic or perfectly inelastic?
- Elasticity has a value between 0 and infinity.
- If the elasticity equals 0, the demand is perfectly inelastic (vertical line).
- Between 0 and 1, demand is inelastic: percentage change in quantity demanded is
less than percentage change in price.
- If the elasticity is 1, the elasticity is unit elastic: percentage changes are the same.
- If the elasticity is greater than 1, the demand is elastic.
- If the elasticity is equal to infinite, the demand is perfectly elastic. [à p.76-77]
4. How is the price elasticity of supply calculated? Explain what this measures.
- To what extent the quantity supplied responds to a change in price. [à p. 85]
(𝑄2 − 𝑄1)
( )
(𝑄2 + 𝑄1)
𝑃𝑟𝑖𝑐𝑒 𝑒𝑙𝑎𝑠𝑡𝑖𝑐𝑖𝑡𝑦 𝑜𝑓 𝑠𝑢𝑝𝑝𝑙𝑦 (𝒎𝒊𝒅𝒑𝒐𝒊𝒏𝒕 𝒇𝒐𝒓𝒎𝒖𝒍𝒂) = 2
𝑃2 − 𝑃1
( )
𝑃2 + 𝑃1
2
5. Is the price elasticity of supply usually larger in the short run or in the long
run? Why?
- Usually, supply is more elastic in the long run than in the short run. The quantity
supplied can respond only substantially to price changes in the long run.
- In the short run, firms might find it hard to respond to a change in price by changing
their output immediately.
- Over longer periods, firms can build or close factories, hire or fire staff and buy or
sell capital; and firms can enter and exit the market. [à p.83]
6. What are the main factors that affect the price elasticity of supply? Think of
some examples to use to illustrate the factors you cover.
- Except for the time period:
- Productive capacity. In the short run, capacities of business are quite finite.
- Size of the firm/industry. Supply may be more elastic in smaller firms than in larger
ones.
- The Mobility of Factors of Production. If the mobility of a factor of production is high,
4
, Economics, Markets & Organisations I “Economics” (Mankiw & Taylor)
Questions for Review answered (Tahrim Ramdjan), version for Final Exam
Topic: Supply and Demand. Chapters 3 to 6
then the supply of things concerning this factor might be elastic.
- Ease of Storing Stock/Inventory. Stocks can be built up in some firms to enable the
firm to be more elastic, i.e. to be more able to respond to changes in prices. [à p. 83-84]
7. A business person reads that the price elasticity of demand for the product
they sell is 1.25. If the person wishes to increase revenue should they increase
or reduce price? Explain.
- They should reduce price to increase revenue, because otherwise, if the price would
rise, the demand would fall higher than the price rose.
8. In the very short run, the price elasticity of demand for tobacco products is
very low but over the medium term is less so. Explain.
- In the short run, people will keep smoking their favourite brand. But over time, they
will notice how their income is affected by the extra costs they need to pay for their
tobacco, so they will switch to another product.
9. What do we call a good whose income elasticity is less than 1?
- Normal goods of necessity.
- The quantity demanded for this product never rises or falls strong as a result of a
change in price, because the goods are necessary to people.
10. What factors might affect the price elasticity of supply for a commodity such as
rubber in the short run and the long run? Explain.
- In the short run, price elasticity of supply might be affected by the use of production
factors when producing rubber. It depends which factors are used and to what extent
they are being used. For instance, production dependent on lots of factories and
machinery is more difficult to alter than production based on lots of labour.
- In the long run, price elasticity of supply might be affected by the availability of
substitutes to rubber. If more substitutes for rubber appear, then the elasticity will only
become greater.
5 Background to demand: theory of consumer choice
1. What are the main assumptions of the standard economic model?
- Buyers are rational.
- More is preferred to less.
- Buyers seek to maximize their utility.
- Consumers act in self-interest and do not consider the utility of others. [à p.102]
2. A consumer has income of €3,000. Wine is priced at €3 a glass and cheese is
priced at €6 a kilo. Draw the consumer’s budget constraint. What is the slope of
this budget constraint?
see next page
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