Answers to Workshop 2

Demand and Supply

1. The following passage refers to the operation of a free-market economy. Delete the words (in
italics) which are incorrect.

In a totally free-market economy, the quantities of each type of good that are bought and sold,
and the amounts of factors of production (labour, land and capital) that are used, are
determined by the decisions of individual households and firms through the interaction of
demand and supply.

In goods markets, households are demanders and firms are suppliers. In labour markets,
households are suppliers and firms are demanders.

Demand and supply are brought into balance by the effects of changes in price. If supply
exceeds demand in any market (a surplus), the price will fall. This will lead to a rise in the
quantity demanded but a fall in the quantity supplied. If, however, demand exceeds supply
in any market (a shortage), the price will rise. This will lead to a fall in the quantity
demanded and a rise in the quantity supplied. In either case, the adjustment of price will
ensure that demand and supply are brought into equilibrium, with any shortage or surplus
being eliminated.

2. How will the market demand curve for a ‘normal’ good shift (i.e. left, right or no shift) in each of
the following cases?

(a) The price of a substitute good falls ..........................................................................................left

(b) Population rises ..................................................................................................................... right

(c) Tastes shift away from the good ..............................................................................................left

(d) The price of a complementary good falls ............................................................................. right

(e) The good becomes more expensive ......................................... no shift (movement along curve)
3. How will the market supply curve of a good shift (i.e. left, right or no shift) in each of the
following cases?
(a) Costs of producing the good fall. .......................................................................................... right
(b) Alternative products (in supply) become more profitable. .....................................................left
(c) The price of the good rises. .............................................................................................. no shift
(d) Firms anticipate that the price of the good is about to fall. .................................................. right

4. How will the following changes affect the market price of wheat flour (assuming that the market is
initially in equilibrium)? In each case, sketch what happens to the demand and/or supply curves
and, as result, what happens to the equilibrium price.

(a) People consume more bread. (b) The discovery of a new cheaper way of
milling flour.

Price Price

S1 S1
S2

P2

P1 P1

P2

D2
D1 D1
Q1 Q2 Quantity Q1 Q2 Quantity

Price Price

(c) The prices of other grains rise.

S
(d) Rice and potatoes fall in price.
1 S1
Price Price
S2
S1 S1
P1 P1

P2
P1 P1
D1 P2 D1
Q1 Quantity Q1 Quantity

D1 D2 D1

Q2 Q1 Quantity Q1 Q1 Quantity

Price Price

S1 S1
2
5. The diagram below shows the demand for and supply of petrol. The market is initially in
equilibrium at point x.

There is then a shift in the demand and/or supply curves, with a resulting change in equilibrium
price and quantity.

To which equilibrium point (a, b, c, d, e, f, g or h) will the market move from point x after each of
the following changes?

S2
S0
S1
a
h b
Price

g x c

f d

D1

D0
D2

Quantity

The market for petrol

(a) A rise in the cost of refining petrol. ............................................................................................ h

(b) A fall in bus and train fares. ......................................................................................................... f

(c) A fall in the price of crude oil and an increase in the price of cars. ........................................... e

(d) A rise in tax on petrol and a reduction in tax on cars. ................................................................ a

3
6. The demand and supply schedules for wheat in a free market are as follows:
Price per tonne (£) 120 160 200 240 280 320 360 400
Tonnes demanded per week 725 700 675 650 600 550 500 425
Tonnes supplied per week 225 300 400 500 600 750 1000 1300

(a) Draw the demand and supply curves on the following diagram:

400
S
360

320
Price (£ per tonne)

280

240

200

160
D
120
0 200 400 600 800 1000 1200 1400 1600
Quantity (tonnes per week)

(a) What is the equilibrium price? ..............................£280 per tonne (where D = S = 600 tonnes)
(b) Suppose the government fixes a maximum price of £200 per tonne. What will be the effect?
............................................................................................ Shortage of 275 tonnes (675 – 400)

(c) Suppose that supply now increases by 150 tonnes at all prices. Enter the new figures.
Price per tonne (£) 120 160 200 240 280 320 360 400
Tonnes demanded per week 725 700 675 650 600 550 500 425
(old) Tonnes supplied per week 225 300 400 500 600 750 1000 1300
(new) Tonnes supplied per week 375 450 550 650 750 900 1150 1450

(d) How much will price change from the original equilibrium (assuming that the government no
longer fixes a maximum price)? How much more will be sold?
Change in price ............................................................................................ Fall by £40 to £240

Change in quantity ....... Rise by 50 from 600 to 650 (i.e. less than the 150 increase in supply)