CFU #4: Supply & Demand

Which of the following will cause the demand for a normal good to increase?

• A decrease in consumers’ income

• A decrease in the price of a complementary good

• A decrease in the price of a substitute good

• A decrease in the price of the good

• A decrease in the number of consumers

Answer explanation

A decrease in the price of a complementary good will lead to an increase in demand for the normal good. When goods are complements of each other, this means that the goods are often used together, and therefore consumption of one good tends to enhance consumption of the other.

Which of the following best describes the law of demand?

• When income increases, the demand for goods increases.

• When the price of a good decreases, the demand for the good increases.

• When the price of a good decreases, the quantity demanded of the good decreases.

• When the price of a good increases, the quantity demanded of the good decreases.

• When the demand for a good increases, consumers’ willingness and ability to buy the good increases.

Answer explanation

The law of demand describes the negative relationship between the price and quantity demanded. When the price of a good increases, there will be an upward movement along the demand curve for the good, resulting in a decrease in the quantity demanded of the good.

Assume that good X is a normal good. If the price of good X increases, what will happen?

• The substitution and income effects will both lead to more of good X being purchased.

• The substitution and income effects will both lead to less of good X being purchased.

• The substitution effect will lead to more of good X being purchased, while the income effect will lead to less of good X being purchased.

• The substitution effect will lead to less of good X being purchased, while the income effect will lead to more of good X being purchased.

• There will be no income effect because only the price of good X has changed.

Answer explanation

When the price of a good changes, there is both a substitution effect and an income effect. For a normal good, both the substitution effect and the income effect will lead to less of good X being purchased. The substitution effect refers to the consumer’s incentive to substitute higher priced goods with lower priced goods, resulting in a decrease in quantity demanded caused by the increase in the price of a normal good. The income effect refers to the decrease in a consumer’s purchasing power caused by an increase in the price of a normal good.

Which of the following changes will lead to an increase in the supply of good X?

• An increase in the price of good X

• An increase in the wages of labor used to produce good X

• A decrease in the price of energy, a key input to the production of good X

• An increase in the demand for good X

  
  

• A decrease in the number of sellers of good X

Answer explanation

A decrease in input prices (energy prices) decreases the cost of production and shifts the supply curve to the right. As a result, more of the good will be offered for sale at each possible price for the good.

Which of the following statements about the market supply curve is true?

• An increase in input prices will shift the market supply curve to the right.

• At each price, a horizontal summation of the quantity supplied by each firm will yield the market supply curve.

• At each quantity supplied, a vertical summation of the price set by each firm will yield the market supply curve.

• A decrease in the price will shift the market supply curve to the left.

• The law of supply states that the market supply curve may shift right, shift left, or remain the same as the price increases.

Answer explanation

The market supply is the total quantity of a good or service all producers are willing to provide at the prevailing set of relative prices during a defined period of time. Therefore, the market supply curve is derived by the horizontal summation of the quantity supplied by each firm in the market at each price.

Which of the following statements relating to supply is true?

• An increase in an input price will lead to an increase in supply.

  
  

• An increase in the price of a good will lead to an increase in the supply of the good.

• A decrease in consumers’ income will lead to a decrease in the supply of the good.

• A decrease in the price of a good will lead to a decrease in the quantity supplied of the good.

• A decrease in the price of a substitute good in production will lead to a decrease in the supply of another substitute good.

Answer explanation

This describes the law of supply, which describes a movement up along a given supply curve—a decrease in price causes a decrease in the quantity supplied of the good.