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Chapter 3: Demand, Supply, and Price ___________________________________

Answers to Study Exercises Fill-in-the-Blank Questions

Question 1 a) desired; actual b) time; time; flow c) price; quantity demanded; increases d) consumers’ income; prices of other goods; tastes; population; changes in weather e) ceteris paribus; constant Question 2 a) desired; actual b) time; time; flow c) price; quantity supplied; increases d) prices of inputs; technology; taxes or subsidies; prices of other products; number of suppliers; changes in weather

Question 3 a) supply; left; decrease; supply b) demand; right; increase; demand c) demand; right; increase; demand d) supply; left; decrease; supply e) supply; left; decrease; supply f) demand; left; decrease; demand Question 4

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a) negatively b) positively c) supply; demand d) equals e) rise; equilibrium quantity f) rise; equilibrium quantity

Review Questions Question 5 a) Decrease in quantity demanded of fish (movement up along the demand curve due to the resulting increase in price) b) Decrease in quantity demanded of fish (movement up along the demand curve after the price rises) c) Demand for fish decreases (demand curve shifts to the left) d) Demand for fish decreases (demand curve shifts to the left) e) Demand for fish decreases (demand curve shifts to the left) f) Demand for fish increases (demand curve shifts to the right) Question 6 This is a straightforward repetition of the example given in the text, only now applied to housing. a) An increase in population (or average household income) will shift the demand curve for housing to the right and raise equilibrium house prices. b) As prices rise, individual households will reduce the quantities they demand (perhaps by buying smaller houses or by only buying later in life) thus moving upward along the demand curve. The word “prohibitive” may lead some students to make the error in believing prices are so high that no one is buying housing. But, of course, prices stay high only if there are enough purchasers willing to take up all of the available supply at those high prices. The two observations are not inconsistent—they refer to two different phenomena. Question 7

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a) The finding that eating chicken can improve your health will likely lead to an increase in the demand for chicken (and a reduction in the demand for less healthy meats). This will be shown by a rightward shift in the demand curve for chicken. b) As the price of beef rises, consumers will substitute away from beef and toward other meats, including chicken. This will be shown by a rightward shift in the demand curve for chicken. c) If chicken is a normal good—meaning that consumers want more of it when their real income rises—then the rise in household income leads to an increase in the demand for chicken. This will be shown by a rightward shift in the demand curve for chicken. Question 8 a) The ideal growing conditions in the Ivory Coast lead to an increase in supply from that country; since it is the world’s largest supplier of cocoa beans, there is likely a noticeable increase in the world supply. The world supply curve shifts to the right. b) The large increase in the world price of coffee beans means that farmers currently growing cocoa beans (in many countries) have a more attractive alternative. If they substitute toward growing more coffee beans and fewer cocoa beans, the supply of cocoa beans falls – a leftward shift in the world supply curve. c) The rise in wages increases the costs for cocoa farmers, making this activity less profitable. Other things being equal, this is predicted to reduce current supply of cocoa beans. The result is a reduction in the world supply of cocoa beans – a leftward shift in the supply curve. d) Apparently the profits being earned by cocoa farmers (in many countries) are high enough to attract entry by new farmers. The entry of new farmers results, after a suitable period required for them to set up their operations, in an increase in the overall supply of cocoa beans. The world supply curve shifts to the right. Question 9 a) The reduction in the size of the peach harvest due to bad weather is a decrease in the supply of peachesa leftward shift of the supply curve. (For a given demand curve, this leads to an increase in equilibrium price.) b) An increase in income leads to an increase in the demand for all normal goods. Assuming restaurant meals are a normal good, there will be a rightward shift in the demand curve for restaurant meals. For a given upward-sloping supply curve, this shock leads to an increase in the equilibrium price and quantity of restaurant meals. This is an increase in the quantity supplied of restaurant meals (caused by the price increase). c) Technological improvements in electronic publishing reduce the cost of producing e-books and therefore cause an increase in supplya rightward shift of the supply curve for e-books. (This causes a fall in the equilibrium price and an increase in equilibrium quantity.)

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d) Greater awareness of the benefits of a low-carb diet lead to a reduction in demand for bread (and other high-carb food items) and thus, for a given supply curve, to a reduction in the equilibrium price and quantity of bread. As price falls, there is a reduction in the quantity of bread supplied. Question 10 The diagram below shows the world market for copper, and the initial equilibrium is shown as point E1, with the initial demand curve D 1 and supply curve S 1. The fast-economic growth in China leads to an increase in China’s demand for copper, and since China is a large economy, this effect is strongly felt in the world copper market; the world demand curve therefore shifts to the right, to D2. The explosion in the Chilean port causes a temporary reduction in the world supply of copper because some large fraction of the world’s copper, even though ready for shipment, cannot get to market. This event leads to a leftward shift of the supply curve, to S 2. The new equilibrium is shown at point E2. Each of these events on their own would be predicted to lead to an increase in the equilibrium price of copper; when acting together, the effect on the world price will be even larger. The overall effect on the equilibrium quantity of copper exchanged is unclear without knowing the relative sizes of the two shifts, although the case we have drawn shows the case where the demand increase outweighs the supply reduction and so overall equilibrium quantity rises.

Question 11 See the two diagrams below, which both show an increase in the demand for kale but little or no increase in the equilibrium price. Part (a) shows an increase in demand but a supply curve that is almost horizontal, indicating that producers can easily increase their output in response to an increase in demand. The effect of the increase in demand on price is negligible. Part (b) shows a more conventional market with an upward-sloping supply curve. In this case, the increase in demand for kale occurs together with an increase in the overall supply (possibly

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unconnected events) and the effect on equilibrium price is negligible.

Question 12 The figures below show the world market for wheat on the right and the Canadian market for wheat on the left. Since wheat is an internationally traded good, its (single) world price is determined by the intersection of the world demand and world supply curves. With the world supply curve given by S0, the equilibrium world price is p0. At this world price, Canada is a net exporter—shown in the left diagram by an excess supply in Canada at price p0. Russia is a major producer of wheat and therefore contributes substantially to the world supply of wheat. A severe drought in Russia will reduce the Russian crop and have a significant effect on the world’s supply of wheat, shifting the supply curve to the left from S0 to S1. This will drive the world price up from p0 to p1. North American wheat farmers benefit because they experience a higher world price at which to sell their product, but suffer none of the quantity consequences of the drought. In fact, they increase their quantity supplied from point A to point B in the left-hand figure. Their income is unambiguously higher than it would be had the Russian drought not happened. The increase in income for Canadian wheat farmers is shown by the shaded area. (Note that the higher price leads to more wheat production in Canada but less wheat consumption; the difference represents an increase in Canadian wheat exports to other countries.)

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Problems

Question 13 a) decrease; quantity demanded b) to the right; increase c) increased; decreased d) quantity demanded e) The appropriate diagram is shown below.

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Question 14 a) The equilibrium price, where quantity demanded equals quantity supplied, is $320 per tonne. b) If the price were (stuck at) $280, the quantity actually exchanged would be governed by supply, and would be equal to 8.5 million tonnes. c) If the price were (stuck at) $360, the quantity actually exchanged would be governed by demand, and would be equal to 6.5 million tonnes. d) At $280, there is excess demand equal to 4.0 million tonnes (per period). e) At $360, there is excess supply equal to 4.0 million tonnes (per period). f) At a price of $280, the excess demand will lead consumers to bid up the price in their efforts to satisfy their (excess) demands. Price will eventually rise. g) At a price of $360, the excess supply will lead producers to bid down the price in their efforts to sell their (excess) supply of the product. Price will eventually fall. Question 15 a) At a price of $4.00 per can, quantity demanded is 2 million cans per year and quantity supplied is 8 million cans per year. There is a surplus of 6 millions cans per year. b) At a price of $1.50 per can, quantity demanded is 12 million cans per year and quantity supplied is 3 million cans per year. There is a shortage of 9 millions cans per year. c) Equilibrium, where quantity demanded equals quantity supplied, occurs at a price of $3.00 per can and at a quantity of 6 millions cans per year. Question 16 a) The demand and supply curves for coffee are shown below. Note that the horizontal axis has a break in the scale so that we can focus on the range of quantity beyond Q=10.

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b) From the table in the question, or by reading off the diagram, we can see the following pattern of excess demands and supplies. Recall that excess demand at any given price is equal to quantity demanded minus quantity supplied. Price $2.00 2.40 2.60 3.50 3.90 4.30

Excess Demand (+) or Supply (-) +18 +14 +9 0 - 5 - 9

c) The equilibrium price is the price at which quantity demanded equals quantity supplied. In other words, it is the price at which excess demand is exactly zero. From the table or the diagram we can see that the equilibrium price of coffee is $3.50 per kilogram. d) If a minimum price for coffee were set equal to $3.90 per kg, there would be an excess supply of coffee equal to 5 million kg per year. The only way the government(s) could enforce this minimum price, and prevent the price from falling to the free-market equilibrium level, would be to purchase the excess supply of 5 million kg annually.

Question 17 a) From 2015 to 2016, the price rises and the quantity is unchanged. One possibility is a reduction in supply (crop failure?) with a vertical demand curve. Another possibility is an increase in

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demand with a vertical supply curve. A less extreme and thus more likely possibility is an increase in demand combined with a reduction in supply that leaves Q unchanged. b) From 2015 to 2016, the price falls and quantity increases. The simplest possibility is that there has been an increase in supply (a bumper crop?) and no change in demand – but quantity demanded increases in response to the decline in price. c) From 2015 to 2016, the price and quantity both fall. The simplest possibility is that there has been a decline in demand (a recession which reduces demand for the crop?). The supply curve is stable but quantity supplied falls in response to the decline in price. d) From 2015 to 2016, the price is stable but quantity rises. One possibility is that demand increases and the supply curve is horizontal – reflecting that producers can easily produce more of the crop in response to the increase in demand. Another possibility is that both demand and supply increase, but keep the overall price unchanged. Question 18 a) The demand curve is: QD = 100 – 3p. This is a straight-line demand curve with a slope of –1/3. The horizontal intercept ( p=0) is QD=100. The vertical intercept ( QD=0) is p=33.33. The supply curve is: QS = 10 + 2p. This is a straight-line supply curve with a slope of ½. When p=0, QS = 10. Both curves are plotted below.

b) Equilibrium requires QD = QS. This equality defines the equilibrium price, p*. c) Imposing QD = QS, we have 100 - 3 p = 10 + 2p. Solving for p we get 90 = 5 p or p = 18. This is what we call p*, the market-clearing price. d) Substituting p* = 18 into the demand function we get Q* = 100 - 3(18) = 46. If we substitute p* instead into the supply function we get Q* = 10 + 2(18) = 46. (Since the demand and supply curves intersect at p* = 18, Q* must be the same whether we use the demand curve or the supply curve.)

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e) Now there is an increase in demand. The new demand function is QD = 180 - 3p. Equilibrium requires QD = QS which means 180 – 3 p = 10 + 2p. The solution for p* is therefore 5 p* = 170 or p* = 34. Substituting p* back into the demand curve we get Q* = 180 - 3(34) or Q* = 78. The law of demand says that an increase in demand leads to a rise in both the equilibrium price and the equilibrium quantity. Both predictions are correct. f) Now with the new demand curve in place there is an increase in supply. The new supply curve is QS = 90 + 2p. Equilibrium requires 180 – 3p = 90 + 2p. This gives p* = 18. Substituting p* back into the demand curve leads to Q* = 180 – 3(18) or Q* = 126.

Question 19 The solution approach is simple. Equate QD and QS to solve for P*. Then substitute this P* back into the demand (or supply) curve to solve for Q*. a) P* = 1, Q* = 8 b) P* = 9, Q* = 1180 c) P* = 120, Q* = 70 d) P* = 2000, Q* = 5600 e) P* = 50, Q* = 5000 *****...