Quiz 3: Demand, Supply, and the Market Process

Business

An increase in demand is defined as the at the given price the consumer wants to purchase more goods. The demand for a commodity is not only the function of the price of that commodity but is also dependent on various other factors as well like the income level of the potential consumers, price of complementary goods, price of substitute goods, future anticipation of price fluctuation and many other factors. (a)Higher Pork Prices: As pork and beef are considered as strong substitutes. Substitute goods are those goods if the price of one good increase the quantity of the other good increases. Increase in the demand for beef causes and increase in the price of the pork. This increase in the demand causes the demand curve to shift outward. Hence, an increase in the current demand in beef has higher pork prices. Therefore, the correct option is (a). (b)Higher consumer income : When the income increases the demand for beef increases. An increase in the consumer income will cause the demand curve to shift outward. Hence, an increase in consumer income increases the current demand for beef. Therefore, the correct option is (b). (c)Higher prices of feed grains used to feed cattle : An increase in the prices of the grains results in a change in the supply curve and not demand curve. Hence, an increase in the prices of the grains does not increase the current demand of beef. Therefore, option is (c) is not correct. (d)Widespread outbreak of mad cow or hoof-and-mouth disease: Widespread outbreak of mad cow or hoof-and-mouth disease will effect the supply of the beef and the demand for the beef. This outbreak generally effects the killing of cattle on large scale thus reducing the supply. Hence, Widespread outbreak of mad cow or hoof-and-mouth disease does not increase the current demand of beef. Therefore, option is (d) is not correct. (e)An increase in the price of the beef: An increase in the price of the beef decreases the demand for beef. Hence, an increase in the price of the beef does not increase the current demand of beef. Therefore, option is (e) is not correct. Hence the correct options are (a) and (b).

A demand curve represents various combinations of quantity demanded of a product at different prices. Demand of a product depends on various factors like prices of the product, income of the consumer, prices of complementary goods, prices of substitute goods, taste and preferences of consumer, future expectations etc. Keeping every other factor fixed : While deriving the demand curve for a product, all other factors affecting the demand curve are kept unchanged. This condition is also known as ceteris paribus. Following factors are kept constant while constructing demand curve: (i) Income of the consumer : The income of the consumer is assumed do not change and thus will not affect the quantity demanded. (ii) Prices of complementary goods : Complementary goods are those goods which are used together with main good. Like car and petrol. If the price of complementary good changes (say for example petrol), the demand of the good (i.e. car) can also change. Thus, the price of the complementary goods is considered constant. (iii) Prices of substitute goods: Substitute goods are those goods which are used in place of the original good. Like tea and coffee. If the price of substitute good changes, the demand of the original good will also be affected. Thus, it is also considered to be constant. (iv) Fashion, Taste and preferences: The demand of a commodity is also dependent on the external factors like fashion, taste and preferences of the consumers, and thus are to be considered constant. Why the demand Curve slopes downward to the right: When all the other factors that affect the demand of a commodity are constant, the demand curve shows downward sloping to the right that it shows the inverse relationship between the demand of a commodity and its price. In other words, consumer demands more of the goods at low prices and vice versa. The demand curve slopes downward to the right due to following three reasons : 1. Law of diminishing marginal utility: As the consumer consumes more and more of the commodity his marginal utility of that commodity declines. Suppose if consumer buy first unit of a commodity, he buys it at higher prices (say $10). But he may not buy the second unit of same commodity at same prices in same time because his marginal utility for second unit declines. To get the same level of satisfaction from the second unit, he is ready to buy commodity at low prices (i.e. less than $10). 2. Income Effect: When the price of the commodity declines, purchasing capacity of the consumer increases and thus consumer is able to buy more of the commodity at low prices. 3. Substitution effect: When the price of the commodity declines, the substitute goods become costlier. Thus, the consumer of substitute goods also starts buying the commodity. It results increase in demand of a commodity at low prices. Thus, the above mentioned factors summarize why the demand curve slopes downward to the right.

Law of supply defines the functional relationship between the price of a commodity and the quantity supplied at the corresponding price assuming all other factors influencing the supply of commodity remaining constant. There exist a positive relation between the market price of a good and the quantity supplied at that price. Higher is the market price higher will be the quantity supplied by the supplier. This positive relation between price and quantity supply by the producer is the law of supply. (a) Gasoline is a natural resource and the total reserve is fixed. An increase in the price of the gasoline will not be able to induce the producer to produce more as the cost of production which is mainly the extraction cost of the fuel is fixed and do not vary considerably with change in price. Thus an increase in price of gasoline will not induce the supplier to supply more and hence the law of supply will not hold in case of gasoline supply. (b)Cheating in exam is an offense and when caught it brings penalty. If the price of cheating increases the supply of cheating cannot increase as the supply is restricted by the regulation and involves an increased cost of penalty which can even be more than the price offered for cheating. Hence cheating in exam will not abide the law of supply. (c) Political favors from legislators are favors and hence cannot said to have a market value of the service. Hence law of supply will not hold in this case since the price and supply cannot be positively correlated as legislators and their functions are non tradable. (d) The services of heart specialist conforms the law of supply. The service of a heart specialist has a market value which is the remuneration of the doctor, as the price of doctor increase more and more medical students are induced to specialize in heart and the existing heart specialists are also work for more hours as the piece increases. Thus higher price induces higher supply of service and hence confirms the law of supply. (e) The decision of having children is an outcome of emotional consideration and cannot be attached a monetary angel to it. The law of supply establishes a functional relationship between the price and supply since no price can be attached to children hence the law of supply do not hold. (f) Legal divorces similar to the decision of having children are outcome of emotional consideration and hence do not hold a monetary/market value of the outcome. Consequently the law of supply does not hold in this case too.

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