# Supply and Demand

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2.1 Demand-Supply analysis is the single most important application of economics to real world economic problems. Answer each of the following questions:

- What are the determinants of the demand for a product?
- What is the Law of Demand?
- Which variables cause a “shift in demand” as compared to a “change in the quantity demanded”?
- What are the determinants of the supply of a product?
- What is the Law of Supply?
- Which variables cause a “shift in supply” as compared to a “change in the quantity supplied”?
- Give 5 examples of complements and 5 examples of substitutes.
- What is the significance of equilibrium price and quantity?
- What is the role of the prices in a market economy?
- What is the role of competition in the market?

2.2 Using Demand-Supply graphs predict what will happen to i) the equilibrium price of apples and ii) the equilibrium quantity exchanged of apples in the Quebec market in the short-run in each of the following situations. Support each prediction with a Demand-Supply diagram. Label your axes and use arrows to denote the direction of the changes.

- Consumers acquire a stronger taste for apples;
- Consumer personal disposable income fall;
- The price of oranges and plums drops substantially;
- The price of sugar rises substantially;
- The news report that due to bad weather conditions in Eastern Canada, a large part of this year’s apple production may have been destroyed;
- Apple producers introduce apple-picking equipment in their orchards;
- The wages of apple picking workers rise substantially;
- The price of gasoline drops substantially;
- The prices of apples in the new York State rises substantially above that in Quebec;

2.3 Using the same methodology as above, now predict the equilibrium price and quantity exchanged of apples in each of the following situations:

- Consumers’ tastes and preferences for apples strengthen while (ii) introduction of apple picking machinery is taking place in apple orchards;
- Consumer personal incomes rise while (ii) the wages of apple pickers goes up;
- The price of oranges and plumes falls while (ii) the number of apple producers increases;
- Consumers tastes turn away from apples while (ii) bad weather destroys a large part of the apple production;
- Consumers’ incomes rise while (ii) the prices of oranges and plums fall;

2.6 The demand and supply functions for cow milk in the Quebec market are given by the following equations:

P= 200 – 0.25Q

P= 50 + 0.125Q,

- Where P = Price per ton ($/ton)
- And Q = Quantity of production in 000s of tons per month

- Draw the demand-supply diagram for cow milk in Quebec and determine the market equilibrium price (Pe) and quantity of cow milk exchanged (Qe) each month. What is the dollar value of cow milk sold in Quebec each month?
- Now, suppose that is response to complaints by the Quebec dairy farmers who find the market price too low to earn a decent living the government decides to regulate the market by setting the price of milk to $110.00 per ton. What will be the impact on the quantity demanded and supplied? Illustrate the new government price and its impacts on the diagram above.

2.9 You are given two equations:

P= 40 – 0.2Q [demand equation]

P= 0.2Q [supply equation]

- On graph paper draw a diagram and plot each equation (P on the Y-axis and Q on the X-axis);
- Find algebraically the equilibrium price and quantity exchanged. Are the Pe and Qe the same as a) above?
- Calculate the consumer surplus, the producer surplus and total social welfare

Now, suppose that the supply equation changes to:

P= 4 + 0.2Q

- Using the new demand equation, solve algebraically for the new equilibrium price and quantity exchanged;
- Calculate the consumer surplus, the producer surplus and total social welfare
- What has been the impact on consumer surplus of the shift in the supply?

2.10 You are presented with the following data concerning the demand for and supply of petroleum (crude oil):

Price Demand Supply

($/b) Millions of Barrels per Month

30 100 300

28 120 280

26 140 260

24 160 240

22 180 220

20 200 200

18 220 180

16 240 160

14 260 140

12 280 120

10 300 100

- From the above table determine the algebraic form of the demand and the supply equation. Use P for the price and Q for the quantity, where P is the dependent variable (left-hand-side) and Q is the independent variable (right-hand-side).
- Plot on graph paper the demand and the supply curves for petroleum. What is the slope of the demand curve? What is the slope of the supply curve? From the graph, determine the equilibrium price and quantity exchanged?
- Use your two equations from (a) above and solve algebraically for the equilibrium price and quantity exchanged. Does your answer match the one from (b) above?

2.12 The market demand and supply functions for imported high fashion ladies shoes in Canada are estimated as follows:

P= 150 – 0.00005 Q

P= 50 + 0.0002 Q

- Determine the equilibrium market price (P) and quantity exchanged (Q) annually of shoes and sketch the demand-supply diagram showing the equilibrium values. What is the total revenue accruing to shoe importers?
- Suppose that in response to complaints by domestic shoe manufacturers the government considers the imposition of a tariff (excise tax) of $20 per pair on the importation of shoes. Determine the new equilibrium price and quantity exchanged if this tariff is applied. What will the net revenue accruing to shoe importers be? What will be the flow of tax revenue to the government from the tariff?
- Suppose that as a counter measure the government proposes to quota to restrict the importation of a shoes to Q = 300,000 units per annum, instead of the tariff. Determine the new equilibrium price and quantity exchanged. What will be the revenue accruing to the shoe importers? What will be the flow of tax revenue to the government?
- If you were an economic advisor to the shoe importers’ association, which of the two options would you recommend to your members?

3.1 You are given the following price and quantity data:

P Q TR triangleTR MR Ep

10 0

9 20

8 40

7 60

6 80

5 100

4 120

3 140

2 160

1 180

0 200

- Calculate total revenue (TR=PxQ); the change in TR (TR2-TR1); the marginal revenue (MR=triangleTR/triangle) and the price elasticity of demand (Ep) for each successive pair of prices and quantities using the arc formula.
- At which price is total revenue (TR) maximized? What is MR and Ep at this price?
- On one graph, plot the demand curve (P vs. Q) and the marginal revenue (MR) curve (MR vs. Q) where P and MR are on the Y-axis and Q on the X-axis.
- On a separate graph, plot the TR curve (TR vs. Q) where TR is on the Y-axis and Q on the X-axis.
- Describe what happens to TR, MR and Ep as the price falls from $10 to $5;

Describe what happens to TR, MR and Ep as the price falls from $5 to 0

What should be the value of MR and of Ep to maximize total revenue?

3.2 Suppose the price-elasticity of demand for flat-screen plasma TVs is Ep = -2.0:

- a) What is the meaning of this value? How do you interpret it?
- b) What will happen to the quantity demanded if i) the price goes up 10%; ii) the price falls by 10%;
- c) If the seller of plasma TVs wants to maximize his total sales revenue (TR) would you recommend he lower or raise his price? Explain why.

3.3 Suppose that the income elasticity of demand for flat-screen TVs is Ei = 5.0:

- a) What is the meaning of the value? How do you interpret it?
- b) What will happen to the quantity demanded if i) personal disposable income rises by 5%; ii) personal disposable income falls by 5%?
- c) Is this a normal good, an inferior good or a superior good?

3.4 Suppose that the cross elasticity of demand between flat screen plasma TVs and the price of flat screen LCD HDTVs is Exy = +1.2 and the cross elasticity between flat screen plasma TVs and the price of surround sound home entertainment systems is Exy = +1.5. How does a 10% drop in the price of LCD HDTVs affect the demand for plasma TVs sets? And how does a similar 10% drop in the price of home entertainment systems affect the demand for plasma TVs? Are they substitutes or complements? Explain why?

3.6 Suppose that the short-term and long-term price elasticity of supply for Canadian Durum wheat is S-T-Ep = +0.2 and L-T-Ep= +1.4. Currently the average price of wheat is 4,000,000 tons per annum. Forecast the production of wheat one year ahead and five years ahead using the above elasticity values based on the following assumptions:

- The price of wheat rises 50%
- The price of wheat rises 100%
- On a graph draw the short-run and the long-run supply of wheat curbe

3.10 The market demand and supply functions for hotel rooms in the Village of Kingston are estimated as follows:

Demand: P= 500 – 0.0005 Q

Supply: P = -1500 + 0.002 Q

- Determine the equilibrium price (P) and quantity exchanged (Q) of hotel rooms in the city. Sketch the demand/supply diagram and indicate all key values. How much is spent annually on hotel accommodations in the city?

- B) The City Council is debating a motion to introduce a hotel tax in the city of $10 per room night. The Mayor of the city in a recent press conference assured the hotel operators that the impact of the tax on their operations will be minimal since the tax is intended to be paid by tourists, who once they book, have little choice over not paying the tax. Do you agree with the Mayor’s assertion? (Calculate the impact of the room tax on equilibrium P and Q and support your answer with sound economic reasoning). Which is relatively less elastic, the demand or the supply for hotel rooms?

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**Category**: Economics