SECTION 2 REVIEW

Module 5

1. The supply and demand model illustrates how a competitive market, one with many buyers and sellers of the same product, works.

2. The demand schedule shows the quantity demanded at each price and is represented graphically by a demand curve. The law of demand says that demand curves slope downward, meaning that as price decreases, the quantity demanded increases.

3. A movement along the demand curve occurs when the price changes and causes a change in the quantity demanded. When economists talk of changes in demand, they mean shifts of the demand curve—a change in the quantity demanded at any given price. An increase in demand causes a rightward shift of the demand curve. A decrease in demand causes a leftward shift.

4. There are five main factors that shift the demand curve:

   • A change in the prices of related goods, such as substitutes or complements

   • A change in income: when income rises, the demand for normal goods increases and the demand for inferior goods decreases

   • A change in tastes

   • A change in expectations

   • A change in the number of consumers

Module 6

5. The supply schedule shows the quantity supplied at each price and is represented graphically by a supply curve. According to the law of supply, supply curves slope upward, meaning that as price increases, the quantity demanded increases.

6. A movement along the supply curve occurs when the price changes and causes a change in the quantity supplied. When economists talk of changes in supply, they mean shifts of the supply curve—a change in the quantity supplied at any given price. An increase in supply causes a rightward shift of the supply curve. A decrease in supply causes a leftward shift.

7. There are five main factors that shift the supply curve:

   • A change in input prices

   • A change in the prices of related goods and services

   • A change in technology

   • A change in expectations

   • A change in the number of producers

Module 7

8. An economic situation is in equilibrium when no individual would be better off doing something different. The supply and demand model is based on the principle that the price in a market moves to its equilibrium price, or market-clearing price, the price at which the quantity demanded is equal to the quantity supplied. This quantity is the equilibrium quantity. When the price is above its market-clearing level, there is a surplus that pushes the price down. When the price is below its market-clearing level, there is a shortage that pushes the price up.

9. An increase in demand increases both the equilibrium price and the equilibrium quantity; a decrease in demand has the opposite effect. An increase in supply reduces the equilibrium price and increases the equilibrium quantity; a decrease in supply has the opposite effect.

10. Shifts of the demand curve and the supply curve can happen simultaneously. When they shift in opposite directions, the change in price is predictable but the change in quantity is not. When they shift in the same direction, the change in quantity is predictable but the change in price is not. In general, the curve that shifts the greater distance has a greater effect on the changes in price and quantity.

Module 8

11. Even when a market is efficient, governments often intervene to pursue greater fairness or to please a powerful interest group. Interventions can take the form of price controls or quantity controls, both of which generate predictable and undesirable side effects, consisting of various forms of inefficiency and illegal activity.

12. A price ceiling, a maximum market price below the equilibrium price, benefits successful buyers but creates persistent shortages. Because the price is maintained below the equilibrium price, the quantity demanded is increased and the quantity supplied is decreased compared to the equilibrium quantity. This leads to predictable problems including inefficient allocation to consumers, wasted resources, and inefficiently low quality. It also encourages illegal activity as people turn to black markets to get the good. Because of these problems, price ceilings have generally lost favor as an economic policy tool. But some governments continue to impose them either because they don’t understand the effects or because the price ceilings benefit some influential group.

13. A price floor, a minimum market price above the equilibrium price, benefits successful sellers but creates a persistent surplus: because the price is maintained above the equilibrium price, the quantity demanded is decreased and the quantity supplied is increased compared to the equilibrium quantity. This leads to predictable problems: inefficiencies in the form of inefficient allocation of sales among sellers, wasted resources, and inefficiently high quality. It also encourages illegal activity and black markets. The most well-known kind of price floor is the minimum wage, but price floors are also commonly applied to agricultural products.

Module 9

14. Quantity controls, or quotas, limit the quantity of a good that can be bought or sold. The government issues licenses to individuals, the right to sell a given quantity of the good. The owner of a license earns a quota rent, earnings that accrue from ownership of the right to sell the good. It is equal to the difference between the demand price at the quota amount, what consumers are willing to pay for that amount, and the supply price at the quota amount, what suppliers are willing to accept for that amount. Economists say that a quota drives a wedge between the demand price and the supply price; this wedge is equal to the quota rent. By limiting mutually beneficial transactions, quantity controls generate inefficiency. Like price controls, quantity controls lead to deadweight loss and encourage illegal activity.