Self-Check Questions

3.5 Demand, Supply, and Efficiency

Consumer surplus is the gap between the price that consumers are willing to pay, based on their preferences, and the market equilibrium price. Producer surplus is the gap between the price for which producers are willing to sell a product, based on their costs, and the market equilibrium price. Social surplus is the sum of consumer surplus and producer surplus. Total surplus is larger at the equilibrium quantity and price than it will be at any other quantity and price. Deadweight loss is loss in total surplus that occurs when the economy produces at an inefficient quantity.

Self-Check Questions

1 . Review Figure 3.4. Suppose the price of gasoline is $1.60 per gallon. Is the quantity demanded higher or lower than at the equilibrium price of $1.40 per gallon? What about the quantity supplied? Is there a shortage or a surplus in the market? If so, how much? 2 . Why do economists use the ceteris paribus assumption? 3 . In an analysis of the market for paint, an economist discovers the facts listed below. State whether each of these changes will affect supply or demand, and in what direction. a. There have recently been some important cost-saving inventions in the technology for making paint. b. Paint is lasting longer, so that property owners need not repaint as often. c. Because of severe hailstorms, many people need to repaint now. d. The hailstorms damaged several factories that make paint, forcing them to close down for several months. 4 . Many changes are affecting the market for oil. Predict how each of the following events will affect the equilibrium price and quantity in the market for oil. In each case, state how the event will affect the supply and demand diagram. Create a sketch of the diagram if necessary. a. Cars are becoming more fuel efficient, and therefore get more miles to the gallon. b. The winter is exceptionally cold. c. A major discovery of new oil is made off the coast of Norway. d. The economies of some major oil-using nations, like Japan, slow down. e. A war in the Middle East disrupts oil-pumping schedules. f. Landlords install additional insulation in buildings. g. The price of solar energy falls dramatically. h. Chemical companies invent a new, popular kind of plastic made from oil. 5 . Let’s think about the market for air travel. From August 2014 to January 2015, the price of jet fuel increased roughly 47%. Using the four-step analysis, how do you think this fuel price increase affected the equilibrium price and quantity of air travel? 6 . A tariff is a tax on imported goods. Suppose the U.S. government cuts the tariff on imported flat screen televisions. Using the four-step analysis, how do you think the tariff reduction will affect the equilibrium price and quantity of flat screen TVs? 7 . What is the effect of a price ceiling on the quantity demanded of the product? What is the effect of a price ceiling on the quantity supplied? Why exactly does a price ceiling cause a shortage? 8 . Does a price ceiling change the equilibrium price? 9 . What would be the impact of imposing a price floor below the equilibrium price? 10 . Does a price ceiling increase or decrease the number of transactions in a market? Why? What about a price floor? 11 . If a price floor benefits producers, why does a price floor reduce social surplus?

Review Questions

12 . What determines the level of prices in a market? 13 . What does a downward-sloping demand curve mean about how buyers in a market will react to a higher price? 14 . Will demand curves have the same exact shape in all markets? If not, how will they differ? 15 . Will supply curves have the same shape in all markets? If not, how will they differ? 16 . What is the relationship between quantity demanded and quantity supplied at equilibrium? What is the relationship when there is a shortage? What is the relationship when there is a surplus? 17 . How can you locate the equilibrium point on a demand and supply graph? 18 . If the price is above the equilibrium level, would you predict a surplus or a shortage? If the price is below the equilibrium level, would you predict a surplus or a shortage? Why? 19 . When the price is above the equilibrium, explain how market forces move the market price to equilibrium. Do the same when the price is below the equilibrium. 20 . What is the difference between the demand and the quantity demanded of a product, say milk? Explain in words and show the difference on a graph with a demand curve for milk. 21 . What is the difference between the supply and the quantity supplied of a product, say milk? Explain in words and show the difference on a graph with the supply curve for milk. 22 . When analyzing a market, how do economists deal with the problem that many factors that affect the market are changing at the same time? 23 . Name some factors that can cause a shift in the demand curve in markets for goods and services. 24 . Name some factors that can cause a shift in the supply curve in markets for goods and services. 25 . How does one analyze a market where both demand and supply shift? 26 . What causes a movement along the demand curve? What causes a movement along the supply curve? 27 . Does a price ceiling attempt to make a price higher or lower? 28 . How does a price ceiling set below the equilibrium level affect quantity demanded and quantity supplied? 29 . Does a price floor attempt to make a price higher or lower? 30 . How does a price floor set above the equilibrium level affect quantity demanded and quantity supplied? 31 . What is consumer surplus? How is it illustrated on a demand and supply diagram? 32 . What is producer surplus? How is it illustrated on a demand and supply diagram? 33 . What is total surplus? How is it illustrated on a demand and supply diagram? 34 . What is the relationship between total surplus and economic efficiency? 35 . What is deadweight loss?

Critical Thinking Questions

36 . Review Figure 3.4. Suppose the government decided that, since gasoline is a necessity, its price should be legally capped at $1.30 per gallon. What do you anticipate would be the outcome in the gasoline market? 37 . Explain why the following statement is false: “In the goods market, no buyer would be willing to pay more than the equilibrium price.”