2. DEMAND and SUPPLY I (basic theory)

2.
DEMAND AND SUPPLY I (Theory)
1. State the Law of Demand: As price rises quantity demanded decreases (ceteris
paribus)
2. What do economists mean by effective demand: Desire to buy and income to
support this.
3h. Explain the Law of Demand using income and substitution effects or the Law of
Diminishing Marginal Utility:
Income effect: As price of good x rises (ceteris paribus), the buying power of income
falls and hence less is demanded of good x (increase in Px → fall in QDx).
Substitution effect: As price of good x rise, (ceteris paribus), the relative price of other
goods is now lower and hence demand for x falls (rise in price x leads to a fall in QDx)
The law of Diminishing Marginal Utility states as more and more of a product is
consumed, each additional unit of consumption brings less and less additional
satisfaction or utility. The 6th can of coke brings less satisfaction than the 5th can of
coke.
4. List 5 major factors which affect the demand for a normal good:
Price of good, income, price of substitutes, price of complements, taste/preference,
level of advertising, price expectation, religion, demography etc
5. The demand for normal/luxury/inferior/substitutes/complements goods rise and the
demand for inferior goods fall as consumers’ incomes rise.
6. Two goods X and Y are normal/luxury/inferior/substitutes/complements (e.g. printer

and ink) if when the price of good X falls the demand for good Y rises.
7. Good X and Y are normal/luxury/inferior/ substitutes/complements (e.g. Pepsi and

coca cola) if when the price of good X rises the demand for good Y rises.
8. State the Law of Supply: Ceteris paribus, as price x rises QSx rises.
9. Explain the possible reasons behind the law of supply:

As Px rises (ceteris paribus), profit margin rises, greater incentive to supply, QSx
rises. Alternatively use the Law of Diminishing Returns.
10. List 5 major factors which affect the supply of a good:

Price of good, cost of production (FoPs), taxes/subsidies, profitability of alternative
use of FoPs, supply shock (natural disasters).
11. Supply and demand may be affected by events. For the following (independent)
events:
(1) Circle rise or fall and demand or supply for good X below the graphs.
(2) Then show the effects of the shifts on the equilibrium price and quantity. Make sure
diagrams are fully labelled and arrows are used to show direction of changes.
a) Price of complementary good b) Sales tax of $1 per packet c) Sales tax of 10 % is imposed
rises imposed
rise / fall demand / supply rise / fall demand / supply rise / fall demand / supply
d) Sales tax falls from 10 % to e) Raw material prices rise f) Consumer incomes fall (normal
3% good)
g) Price of substitute good falls h) Productivity of labour rises i) Consumers expect price of X to
fall tomorrow
j) Profit margins for good rises k) State reduces producer l) Firm’s advertising repulses
subsidy for X by 20 % consumers
12. Assuming a free market for coffee, if the current price is

P1, then it is likely that:
A the demand curve for coffee will shift to the left.
B the supply curve of coffee beans will shift to the right.
C the price of coffee beans will rise.
D the price of coffee beans will remain at P1.
Explain_C There is an excess in demand
13. A fall in demand for petrol from motorists is probably a
result of
A a fall in the costs of aluminium inputs in cars.
B a fall in car insurance premiums.
C a significant fall in price of a monthly pass for
buses and trams.
D a fall in the price of second hand cars.
Explain_C Prices of substitutes have fallen
14. Products S, T, and U are normal goods and related in the following way. Product S is
a complement to product U. Product S is a substitute to product T.
What will happen to the sales of S, when the price of product T falls and the price of product
U rises while the price of product S stays the same?
A Sales of S will be indeterminate give the above information.
B Sales of S will rise.
C Sales of product S will remain unchanged.
D Sales of product S will fall.
Explain_D Demand for S falls, as price U rises, and as price of T falls, Qd for
u falls as S and U are complements, substitute less expensive reinforces.
15. One of the following will not shift the demand curve for good X.
A a change in the income of the buyer.
B a rise in the indirect tax imposed by the government on good X.
C a fall in the price of a substitute product.
D a fall in the price of a complementary product.
Explain_B Indirect tax shifts the supply line which implies movement along the
demand line.
16. One of the following will not shift the supply line for a good.
A a fall in the price of an extensively used input.
B a rise in the consumers’ real incomes
C a rise in the sales tax from 5% to 8%.
D none of the above.
Explain_B As income rises, demand rises, and supply line accommodates the shift
in demand.
17. Which of the following is not held constant for a demand line?
A tastes of buyers.
B prices of competing products.
C the level of advertising.
D the price of the good itself.
Explain_D Along the single demand line, price is the only variable.
18. A standard supply curve is upward sloping because:

A As price rises demand falls.
B Producers charge more as the costs of inputs fall.
C A higher price means a higher sales tax.
D If the price rises, ceteris paribus, the higher profit margins result in increasing
supply.
Explain D The higher profit margins also attract new firms into the industry and
increase supply.
EVALUATION QUESTIONS (Demand & Supply I: Theory)
19. Examine the logic behind the statement, ‘a rise in

demand for rice will cause an increase in the price of rice. The
price rise will then cause a fall in demand until its falls back to its
original level.
- Overall fallacy, confusion between shift and
movement along same demand line
- First statement implies shift in demand curve
- Second statement is a movement along the demand
line
- No logical reason to believe price falls back to Pe1
20. Evaluate the effects of a significant and sustained rise in

the supply of oil on the market for oil, for coal and natural gas,
for cars, for solar panel installation, for pedal bikes, for electric bikes and for public transport.
Supply oil rises, price of oil falls.
- If coal and natural gas are substitutes for oil
Demand for coal + gas falls, Price of coal and gas falls
- Cars and oil are complements.

Price of oil falls, Demand for oil rises, Demand for cars rise
- Solar and oil are weak substitutes

Price of oil falls, Demand for oil rises, Demand for solar installations fall
- Pedal bikes and cars are weak substitutes

Price of oil falls. Demand for cars rises, demand pedal bikes falls.
- Electric bikes and oil are complementary if electricity is generated from oil
though the substitute relation may not as strong.
Price of oil falls, price of electricity may fall raising demand for electric bikes or
demand for electric bikes may fall if cost of running a car fall.
- Oil is an input in public transport, but public transport is also a substitute.

Price of oil falls, cost of production of public transport falls (ceteris paribus), Supply
of public transport rise and demand will accommodate this. However, demand for
public transport falls as a result of driving being a substitute. Net effect on price is a
fall, but on quantity depends which is stronger.
21. Apart from a few years, most of the time it is observed that the average price of
housing is rising even when more and more spaces are being converted to apartments.
Analyse using determinants of demand and supply how this is possible. Evaluate the long-
term implications of house prices rising faster than incomes on average.
- price of housing determined by forces of D&S
- Increase in Price of house due to increase in Demand for house
- Rise in price of houses may lead to rise in demand and subsequently rise in
supply of apartments.
- Overall rate of demand for housing is rising faster than supply of housing =
higher prices
(Diagram, D shifting out more than S shifting out)
- Housing will take up more of income. This will also result in more and more
renters being taken up by housing. There are limits (cannot have 100% income
going into housing) More migration only. Greater pressure on Govt to
intervene.
22. A small fast food kebab shop finds that demand for kebabs vary during the day. At
lunchtimes and on late nights on Fridays and Saturdays the queues are very long and out of
the shop. The waiting period is 23 minutes on average at these times. Evaluate the options
available to the shop including differential pricing.
- Off peak lower price + special offers
- On peak higher price
- Expand business; introduce ordering food whilst in the queue.
- Sell additional services during 25 minutes waiting time
- Pre-prepared. (microwave it)
- Not clear which is more profitable without further information.
23. Evaluate with the help of diagrams:

a) the possible effects of a fall in the price of music downloads on the demand for live
concert attendance. Music download can be substitutes for some consumers and
complements for others.
Live Concerts Live Concerts
b) the probable effects on the demand for music downloads of a rock band when the
price of concerts tickets for the rock band falls. Are the above symmetrical?
Fall in price of concert tickets could cause fall in D(downloads) (substitutes) or rise in
D(downloads) (complement)

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2.

DEMAND AND SUPPLY I (Theory)

6. Two goods X and Y are normal/luxury/inferior/substitutes/complements (e.g. printer

7. Good X and Y are normal/luxury/inferior/ substitutes/complements (e.g. Pepsi and

9. Explain the possible reasons behind the law of supply:

10. List 5 major factors which affect the supply of a good:

12. Assuming a free market for coffee, if the current price is

18. A standard supply curve is upward sloping because:

EVALUATION QUESTIONS (Demand & Supply I: Theory)

19. Examine the logic behind the statement, ‘a rise in

20. Evaluate the effects of a significant and sustained rise in

- Cars and oil are complements.

- Solar and oil are weak substitutes

- Pedal bikes and cars are weak substitutes

- Oil is an input in public transport, but public transport is also a substitute.

23. Evaluate with the help of diagrams:

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