Test Bank for Microeconomics, 21st Edition

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ExamName___________________________________ESSAY. Write your answer in the space provided or on a separate sheet of paper.1)What are some of the characteristics of a market that can be described by a demand and supplymodel?Answer:A market that can be represented by a demand and supply curve is an institution ormechanism which brings togetherlarge numbersofindependently actingbuyersandsellerswho want to exchange somestandardized product. Examples of such markets are a centralgrain exchange, a stock market or a market for foreign currencies.2)Define "demand."Answer:Demand is a schedule or curve that shows the various amounts of a product buyers arewilling and able to purchase at each price in a series of possible prices during a specifiedperiod of time. Demand portrays alternative price/quantity possibilities which can be setdown in a table. The key point to be recognized is that demand is more than a statement ofquantity purchased at a certain price; it is a schedule of quantities which will be demanded atvarious prices, other things being equal, for a specified period of time.3)State the law of demand and explain why the other-things-equal assumption is critical to it.Answer:The law states that, other things being equal, as price increases, the corresponding quantitydemanded falls. Restated, there is an inverse relationship between price and quantitydemanded with everything else held constant. The other-things-equal assumption refers toconstant prices of related goods, income, tastes, and other things that affect demand besidesprice. The law of demand only looks at the relationship between price and quantitydemanded.4)Give two explanations for the law of demand.Answer:First, there is diminishing marginal utility: a decrease in satisfaction that results with anincrease in the amounts of a good or service. The second unit of a good yields lesssatisfaction (or utility) than the first. Second, there are income and substitution effects. Withan income effect, a lower price increases the purchasing power of money income, enablingyou to buy more at lower price. With a substitution effect, a lower price for good X gives anincentive to substitute away from the now relatively high-priced good Y and replace it withthe low-priced good X.5)Suppose that a decrease in the price of feed grain leads to a dramatic decrease in the price of beef.Use the income effect and the substitution effect to explain why there was an increase in thequantity of beef purchased.Answer:The income effect predicts that the quantity of beef purchased will rise when beef prices fallbecause people will now be able to afford more. The purchasing power of their income riseswhen prices fall, assuming other things remain the same.The substitution effect predicts that the lower price of beef will lead consumers of substitutefoods such as chicken and pork to buy more of the relatively less expensive beef and to buyless chicken or pork or other beef substitutes whose prices have not fallen.1

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