SESSION 1 MARKETS

 SESSION 1 MARKETS

Ragan Chapter 3

The Circular Flow of Economic Activity

1. [Figure 1-4] The Circular Flow Diagram shows how Individuals and Firms are linked through Factor Markets and

Goods Markets are guided by Adam Smith’s Invisible Hand. Smith noted [See Timeline T-2] in 1776 that:

a. “Market-determined” prices, wages and interest rates act as signals that automatically “coordinate” the

behaviour of Households and Firms.

b. There is a very limited role for Government (or Economists)

c. The economic outcome is “Efficient” (best)

Product Market

(p)

Households

Work, Save, Buy

Firms

Hire, Borrow, Sell

Labour Market

(w)

Capital Market

(r)

Equilibrium Prices

2. Demand [Section 3.1]

a. List the determinants of Demand: D = D (p | pY , m, pe , u, n) from p. 52 and see Mathematical Appendix

b. Example: D = 12 – 2p

c. Demand curves slope downwards because of Diminishing Marginal Benefits

d. The Reservation Price is equal to ________

e. What do the variables pY , m, pe , u, n represent?

Quantity

Price

. Supply [Section 3.2]

a. List the determinants of Supply S = S (p | pZ , w, r, pe , a, n) from p. 60 and see Mathematical Appendix

b. Example: S = 2p – 4

c. Supply curves slope upwards because of Increasing Marginal Cost

d. The Reservation Price is equal to ________

e. What do the variables pZ , w, r, pe , a, n represent?

Quantity

Price

Equilibrium [Section 3.3, Figure 3-7]

a. Example: D = 12 – 2p, S = 2p – 4

b. Discuss the Equilibrium Mechanism

c. Illustrate and quantify excess supply when p = 5. How would unsuccessful sellers respond to this excess?

d. Illustrate and quantify excess demand when p = 3. How would unsuccessful buyers respond to this

shortage?

Quantity

Price

ECO101H5 Fall 2023 Copyright University of Toronto

Change in Income

5. Demand and supply are S = 2p – 40 and D = 40 – 2p + m where income is initially m0 = 40. Now income increases

to m1 = 80. The equilibrium price will increase by _______ dollars.

Quantity

Change in Related Prices

6. The demand for commodity X is given by DX = 16 – 2pX + 4pY where pY is the price of a Substitute in

Consumption. The supply of commodity X is given by SX = 2pX – 2w where w is the wage paid to employees by

firms in this industry.

a. Illustrate and quantify the equilibrium price and quantity when pY = 1 and w = 2.

b. Illustrate and quantify Demand Shocks. What if pY = 3? [Figure 3-8(i)]

Quantity

Change in Wages

7. The demand for commodity X is given by DX = 16 – 2pX + 4pY where pY is the price of a Substitute in Consumption

(page 53). The supply of commodity X is given by SX = 2pX – 2w where w is the wage paid to employees by firms

in this industry (page 57).

a. Illustrate and quantify the equilibrium price and quantity when pY = 1 and w = 2.

b. Illustrate and quantify Supply Shocks. What if w = 4? [Figure 3-8(ii)]

Quantity

Price

Inference for Changes

8. An economist will infer that a higher equilibrium price and lower equilibrium quantity could be caused by

a. an increase in the price of a substitute in consumption

b. an increase in the price of a complement in production

c. an increase in the price of a complement in consumption

d. an increase in the price of a substitute in production

See Ragan Figure 3-8: There are 4 possibilities

Equilibrium Interest Rates

9. Illustrate and quantify an equilibrium interest rate in Capital Markets

a. Savers supply funds S = 4r – 20

b. Borrower demand funds D = 60 – 4r

c. The Reservation Rates are _______ and ________

d. Illustrate how the elimination of Deposit Insurance that shifts supply to S’ = 4r – 40 will affect the Capital

Market.

Quantity

Price

ECO101H5 Fall 2023 Copyright University of Toronto

Equilibrium Wages

10. Illustrate and quantify an equilibrium wage in Labour Markets given S = 2w – 8 and D = 24 – 2w.

a. Compute and Interpret the Reservation Wages _______ and ________.

b. Identify some factors that would cause your labour supply curve to shift to the right

ECO101H5 Fall 2023 Copyright University of Toronto

Review Questions

1. Demand is given by D = 150 – 0.5p and supply is given by S = 0.5p – 10. Calculate and illustrate the equilibrium

quantity and price.

2. Workers who produce good X were paid w = 2 dollars per hour. They form a union and negotiate a wage of w = 4

dollars per hour. Supply and demand in this market are given by Sx = 0.5px – w and Dx = 8 – 0.5px. Good X is a

complement in consumption for good Y where Dy = 40 – 0.5py – px and Sy = 0.5py. Calculate the equilibrium

price for good Y after the union is formed. Provide diagrams showing the market for good X and good Y

. Calculate and illustrate the equilibrium price and quantity when demand is D = 100 – 0.5p, supply is S = 0.5p – 40

– w and w = 20 is the wage paid to workers in this industry. Next month w = 40.

4. Workers who produce good X were paid w = 2 dollars per hour. They form a union and negotiate a wage of w = 4

dollars per hour. Supply and demand in this market are given by Sx = 0.5px – w and Dx = 8 – 0.5px. Good X is a

substitute in production for good Y where Dy = 40 – 0.5py and Sy = 0.5py – px. Calculate the equilibrium price

for good Y after the union is formed. Provide diagrams showing the market for good X and good Y.

ECO101H5 Fall 2023 Copyright University of Toronto

5. Steel is an important input to the production of cars. Tires and cars are used together by consumers. What will

occur in the market for tires when there is an increase in the price of steel?

a. Price falls, quantity falls. ✓

b. Price falls, quantity rises.

c. Price rises, quantity falls.

d. Price rises, quantity rises.

6. If the legal beer-drinking age is raised from 18 to 21, the changes to the equilibrium price and quantity of beer

are likely to be that

a. Price falls, quantity falls. ✓

b. Price falls, quantity rises.

c. Price rises, quantity falls.

d. Price rises, quantity rises.

7. A reduction in the price of oranges, a substitute in consumption for apples, will tend to

a. Decrease the price of apples. ✓

b. Increase the demand for oranges.

c. Increase the price of apples.

d. Increase the demand for apples.

8. Demand curves are QA = 120 − 3.5pA – 6pB , QB = 100 – 2pB + 3pC and QC = 1500 − 0.5pC . Which of the following

pairs of goods are known to be substitutes in consumption?

a. B and C ✓

b. A and B.

c. A and C.

d. None of these are substitutes.

9. If goods X and Y are complements in consumption and the price of X falls, all other things being equal, the

demand curve for Y will

a. Shift to the right. ✓

b. Shift to the left.

c. Get steeper.

d. Get flatter.

10. If goods X and Y are substitutes in consumption and the price of X falls, all other things being equal, the demand

curve for Y will

a. Shift to the left. ✓

b. Get steeper.

c. Shift to the right.

d. Get flatter.

11. The demand for Product X is given by the equation D = 10

− 2PX

− 3PY + 5M where PX is price, M is income and

PY is the price of a related product Good Y. Based on this equation we can conclude that Good Y is a

a. Complement in consumption. ✓

b. Complement in production.

c. Substitute in production.

d. Substitute in consumption.

12. The demand for Product X is given by the equation D = 10

− 2PX + 3PY

− 5M where PX is price, M is income and

PY is the price of a related product Good Y. Based on this equation we can conclude that Good Y is a

. Complement in consumption.

b. Complement in production.

c. Substitute in production.

d. Substitute in consumption. ✓

13. An increase in the price and quantity of bicycles could be caused by any of the following except

a. An increase in the price of wheelbarrows; a substitute in production. ✓

b. An increase in the price of bus fares; a substitute in consumption.

c. A decrease in the price of bicycle helmets; a complement in consumption.

d. An increase in consumer incomes.

14. A variable that is assumed to be constant along an individual's demand curve for good X is the

a. Amount of X the individual wishes to purchase.

b. Price of a substitute good Y. ✓

c. Consumer's real purchasing power.

d. Price of good X.

15. A factory can produce either X or Y. These goods are called

a. Normal goods

b. Inferior goods

c. Complements in production

d. Substitutes in production ✓

16. Equilibrium price rises and quantity declines. This could have been caused by

a. An increase in the number of buyers

b. An increase in the number of sellers

c. An increase the price of a complement in consumption

d. An increase in wages ✓

17. A consumer with an income of 24 dollars purchases 2 kilograms of blueberries at a price of 3 dollars per kilogram

and 3 kilograms of strawberries at a price of 6 dollars per kilogram. The relative price of strawberries is equal to

a. 6

b. 2 ✓

c. 4

d. 3

18. Technological innovation will cause,

a. an increase in quantity supplied

b. a decrease in quantity supplied

c. an increase in quantity demanded ✓

d. a decrease in quantity demanded

19. A declining equilibrium price and rising quantity is evidence of,

a. an increase in the price of a substitute in consumption

b. an increase in the price of a substitute in production

c. an increase in the price of a complement in production ✓

d. an increase in the price of a complement in consumption

20. A rising equilibrium price and declining quantity is evidence of,

a. an increase in the price of a substitute in production ✓

b. an increase in the price of a complement in consumption

c. an increase in the price of a substitute in consumption

d. an increase in the price of a complement in production

21. An increase in supply can be caused by any of the following except

a. A rise in the price of a complement in production

b. A fall in the price of a substitute in production

c. An improvement in technology

d. An increase in the price of an input to production ✓

22. When sellers expect the price to rise in November

a. The demand in October will increase

b. The supply in October will increase

c. The demand in October will decrease ✓

d. The supply in October will decrease

23. When the price of Good A rises, the price of Good B rises, and the quantity of Good B bought and sold falls.

These goods are

a. Complements in production

b. Substitutes in production ✓

c. Complements in consumption

d. Substitutes in consumption

. Equilibrium prices are determined by DA = 1,000 − 100pA and SA = 200pA − 200 in the market for apples and by

DB = 400 + 200pA − 200pB and SB = 200pB in the market for bananas. Apples are a substitute in consumption for

bananas.

a. Provide a labelled diagram showing equilibrium price and quantity for apples. Provide a second labelled

diagram showing equilibrium price and quantity for bananas.

b. A poor harvest in the apple market shifts supply to SA = 200pA – 800. Update your diagrams to show how

prices and quantities will be affected.

. Equilibrium tuition fees and enrolment are determined by the supply and demand for education. Recently, the

union representing teaching assistants at York University negotiated a wage increase. Teaching assistants are a

key input in the production of undergraduate education.

a. Draw a supply and demand diagram showing equilibrium tuition fees at York, and a second diagram

showing equilibrium tuition fees at UTM.

b. Provide a concise explanation that refers to your diagrams, as to why an increase in the price of an input

at York might affect tuition fees and enrolment at UTM.