1. What are the basic decision-making units in the economy?
The basic decision-making units in the economy are households and firms. Firms transform inputs into goods or services that are sold in markets. Households are the ultimate consumers of these outputs.
2. What are the relationships between these basic units? How does a circular flow diagram illustrate these relationships?
Although firms are the producers of output and households are consumers of these outputs, each of the decision-making units act as both producer and consumer. Firms receive labor, land, and capital inputs from households. In turn, households supply these inputs to firms. The relationships between households and firms are shown in the circular flow diagram.
3. What do we mean by "quantity demanded?" What influences quantity demanded on the part of households?
The amount of a good that consumers are willing to buy of a product is called the quantity demanded at that price. This amount depends not only on the price, but also on other factors, such as income, tastes and preferences, wealth, expectations, and the prices of related goods.
4. What is the demand schedule for a product? What are the main features of a demand curve? What is the law of demand and how is it illustrated by demand curves?
A demand schedule is just a listing of different price-quantity combinations. A demand curve is a graphical representation of the demand for a product. Demand curves have a negative slope, which illustrates the law of demand. This law says that, holding other factors constant, an increase in price will cause a decrease in quantity demanded, and vice versa.
5. What can change the demand for a product? How does the demand curve react to changes in demand? What do we mean by normal goods? Inferior goods? Complementary goods? Substitute goods?
A change in the other factors affecting demand will cause a change in demand and a resulting shift of the demand curve. An increase in demand will shift the demand curve to the right, while a decrease in demand will shift the demand curve to the left. Goods for which an increase in income causes an increase in demand are called normal goods. Inferior goods are goods for which an increase in income causes demand to decrease. If an increase in the price of a related good causes the demand for a good to decrease, the goods are complementary goods. Substitute goods are ones for which an increase in the price of one will cause an increase in the demand for the other.
6. What is the law of supply? What influences the quantity supplied of a good? What are the features of a supply curve? How do supply curves illustrate the law of supply? What factors can cause the supply of a product to change, and how are these changes reflected in the supply curve?
The law of supply states that, all else being equal, an increase in the price of a good will cause an increase in quantity supplied. This means that supply curves are positively sloped. A change in price causes a movement along the supply curve and a change in quantity supplied. A change in other factors affecting producers, such as production costs, technology, or the price of goods related in production, can cause a change in supply and a shift in the supply curve. An increase in supply shifts the supply curve to the right. A decrease in supply shifts the supply curve to the left.
7. What is the equilibrium price for a product? What do we mean by a shortage? A surplus?
The equilibrium price for a product is the price at which the demand and supply curves intersect (meaning the quantity demanded and the quantity supplied at that price are equal). In competitive markets, prices that are higher than the equilibrium price will result in a surplus (excess supply) and the market price will fall. When the market price is lower than the equilibrium price, a shortage (excess demand) will exist and the market price will rise. The equilibrium price is stable under existing demand and supply conditions.
8. How do changes in the supply or demand for a product affect its equilibrium price and quantity?
Changes in supply or demand will cause changes in both the equilibrium price and quantity. An increase in supply will cause a lower price and a greater quantity, and a decrease in supply will cause a higher price and a smaller quantity. An increase in demand will cause a higher price and a greater quantity and a decrease in demand will cause a lower price and a smaller quantity.