HW2: How markets work?

1. What is a competitive market? Briefly describe a type of market that is not perfectly
competitive.

❖ A competitive market is one with many buyers and sellers, each has a negligible
effect on price.
❖ Monopoly is a type of market that is not perfectly competitive. This market has only
one seller or producer for a particular product or service, resulting in higher prices and
lower quantities of goods or services for consumers.

2. Does a change in consumers’ tastes lead to a movement along the demand curve or to
a shift in the demand curve? Does a change in price lead to a movement along the
demand curve or to a shift in the demand curve? Explain your answers.

A change in consumers' tastes leads to a shift in the demand curve, while a change in price
leads to a movement along the demand curve. A curve shifts when there is a change in a
relevant variable that is not measured on either axis. Because tastes are not measured on the
axis, so a change in tastes shifts the demand curve. In contrast, price is on the vertical axis, a
change in price causes a movement along the demand curve.

3. Does a change in producers’ technology lead to a movement along the supply curve or
to a shift in the supply curve? Does a change in price lead to a movement along the
supply curve or to a shift in the supply curve? Explain your answers.

A change in producers’ technology leads to a shift in the supply curve, while a change in
price leads to a movement along the supply curve. Things which are not measured on the axis
will lead to a shift in the supply curve. Because technology is not measured on the axis, it
would result in a shift in the supply curve. At the same time a change in price which is
measured on the vertical axis causes movement along the supply curve.

4. Describe the role of prices in market economies.

Prices play a vital role in market economies because they bring markets into equilibrium. If
the price is different from its equilibrium level, quantity supplied and quantity demanded are
not equal. The resulting surplus or shortage leads suppliers to adjust the price until
equilibrium is restored. Prices thus serve as signals that guide economic decisions and
allocate scarce resources.

5. Define the price elasticity of demand. Explain the relationship between total revenue
and the price elasticity of demand.

❖ Price elasticity of demand measures how much the quantity demanded responds to a
change in price.
❖ The relationship between total revenue and the price elasticity of demand:
- If demand is elastic, an increase in price leads to a decrease in the total revenue.
- If demand is inelastic, an increase in price leads to an increase in the total revenue.
- If demand is unit elastic, changes in price do not affect the total revenue.

6. Define the price elasticity of supply. Explain why the price elasticity of supply might
be different in the long run than in the short run.
 ❖ Price elasticity of supply measures how much the quantity supplied responds to a
change in price.
❖ The price elasticity of supply might be different in the long run than in the short run
because the supply cannot be changed easily in the short amount of time. Whereas in
the long run, suppliers and firms can increase supply by utilizing all factors of
production as well as acquire resources, enter or exit the market.

7. What do we call a good with an income elasticity less than zero? If a fixed quantity of
a good is available, and no more can be made, what is the price elasticity of supply?

❖ A good with an income elasticity less than zero is called inferior good because when
income rises, the demand for good decreases.
❖ If a fixed quantity of a good is available, and no more can be made, the price elasticity
of supply is zero (perfectly inelastic), as the quantity supplied does not change
regardless of change in price.

8. How might a drought that destroys half of all farm crops be good for farmers? If
such a drought is good for farmers, why don’t farmers destroy their own crops in the
absence of a drought?

❖ A drought that destroys half of all farm crops might be good for farmers if the demand
for crops is inelastic. The shift to the left of the supply curve leads to an increase in
price, which raises the total revenue of the farmers.
❖ However, farmers don’t destroy their own crops in the absence of a drought because
no one farmer would have an incentive to destroy his crops, since he takes the market
price as given. This plan only works if all farmers destroyed their crops together, for
example through a government program. Otherwise, it just only hurts their profits.