QUESTION BANK ANSWERS

Unit 3: Producers Behavior and Supply

Q.1. Define Law of Supply?

Ans. The law of supply is the microeconomic law that states that, all other factors
being equal, as the price of a good or service increases, the quantity of goods or
services that suppliers offer will increase, and vice versa. The law of supply says that
as the price of an item goes up, suppliers will attempt to maximize their profits by
increasing the quantity offered for sale.

Q.2. Explain difference between supply and quantity supplied?

Ans. “Supply” is the designated name for the amount of products or services
that are to be provided by a certain company to a market. The supply is
illustrated in a supply curve and in a graph for simplification and illustration of
the relationship between prices and quantities more clearly. It includes all the
possible prices and possible quantities that are available.

Meanwhile, “quantity supplied” is the name for a specific point in the supply
curve. “Quantity supplied” illustrates the amount or quantity that is willing to be
provided for a certain market price. “Quantity supplied” is usually how many in
number depending on the prices and quantity being illustrated for a specific time
period or condition.

Both “supply” and “quantity supplied” can be translated into a graph. “Supply”
can be graphed as the entire supply curve with all the possible prices and
quantity and their intersections. “Quantity supplied” can be seen in the supply
curve. It is one specific point or intersection between a certain price and
quantity.

When the supply increases, the supply curve shifts to the right. If this happens,
the amount of the quantity increases as well as the possible market price. There
are many factors that affect the supply. If the supply deceases, the shift is to the
left as an indicator.

.
.
Q.3. Define Supply Curve?

Ans The supply curve is a graphic representation of the correlation between the cost
of a good or service and the quantity supplied for a given period. In a typical
illustration, the price will appear on the left vertical axis, while the quantity supplied
will appear on the horizontal axis.

Q.4. Explain How a Supply Curve Works?

Ans.  The supply curve will move upward from left to right, which expresses the law of
supply: As the price of a given commodity increases, the quantity supplied increases
(all else being equal).

Note that this formulation implies that price is the independent variable, and quantity
the dependent variable. In most disciplines, the independent variable appears on the
horizontal or x-axis, but economics is an exception to this rule.

Q.5. Explain shift in supply curve?

 Ans. If a factor besides price or quantity changes, a new supply curve needs to be
drawn. For example, say that some new soybean farmers enter the market, clearing
forests and increasing the amount of land devoted to soybean cultivation. In this
scenario, more soybeans will be produced even if the price remains the same,
meaning that the supply curve itself shifts to the right (S2) in the graph below. In other
words, supply will increase.

Other factors can shift the supply curve as well, such as a change in the price of
production. If a drought causes water prices to spike, the curve will shift to the left (S3).
If the price of a substitute—from the supplier's perspective—such as corn increases,
farmers will shift to growing that instead, and the supply of soybeans will decrease
(S3).

If a new technology, such as a pest-resistant seed, increases yields, the supply curve
will shift right (S2). If the future price of soybeans is higher than the current price, the
supply will temporarily shift to the left (S3), since producers have an incentive to wait to
sell.

Q.6. Explain factors that affect supply curve?

Ans. 1. Resource price

If the price of crude oil (a resource or input into gasoline production) increases, the
quantity supplied of gasoline at each price would decline, shifting the supply curve to
the left.

2. Technique of production

If a new method or technique of production is developed, the cost of producing each

good declines and producers are willing to supply more at each price - shifting the
supply curve to the right.

3. Prices of other goods

If the price of wheat increases relative to the price of other crops that could be grown
on the same land, such as potatoes or corn, then producers will want to grow more
wheat, ceteris paribus. By increasing the resources devoted to growing wheat, the
 supply of other crops will decline. Goods that are produced using similar resources are
substitutes in production.

Complements in production are goods that are jointly produced. Beef cows provide not
only steaks and hamburger but also leather that is used to make belts and shoes. An
increase in the price of steaks will cause an increase in the quantity supplied of steaks
and will also cause an increase (or shift right) in the supply of leather which is a
complement in production.

4. Taxes & Subsidies

Taxes and subsidies impact the profitability of producing a good. If businesses have to
pay more taxes, the supply curve would shift to the left. On the other hand, if
businesses received a subsidy for producing a good, they would be willing to supply
more of the good, thus shifting the supply curve to the right.

5. Price Expectations

Expectations about the future price will shift the supply. If sellers anticipate that home
values will decrease in the future, they may choose to put their house on the market
today before the price falls. Unfortunately, these expectations often become self-
fulfilling prophecies, since if many people think values are going down and put their
house on the market today, the increase in supply leads to a lower price.

6. Number of sellers

If more companies start to make motorcycles, the supply of motorcycles would

increase. If a motorcycle company goes out of business, the supply of motorcycles
would decline, shifting the supply curve to the left.

7. Supply Shocks

The last factor is often out of the hands of the producer. Natural disasters such as
earthquakes, hurricanes, and floods impact both the production and distribution of
goods. While supply shocks are typically negative, there can be beneficial supply
shocks with rains coming at the ideal times in a growing season.

Q.7. Define equilibrium price?

Ans.: The equilibrium price is the price where the quantity demanded is equal to the
quantity supplied. That quantity is known as the equilibrium quantity.
 You can visualize the equilibrium price as a ball in bowl. The bowl can can be tipped
and the ball will move, but it will find its way back to a stable place. The equilibrium
price works that same way. At any other price, forces are put into play that will push the
price back towards equilibrium.

To recap, the only stable price is the equilibrium price. If the price is not at equilibrium,
the actions of buyers and sellers will push the price back towards equilibrium.

Q.9. Explain equilibrium price graphically?

Ans. When the supply and demand curves intersect, the market is in equilibrium.
This is where the quantity demanded and quantity supplied are equal. The
corresponding price is the equilibrium price or market-clearing price, the quantity is the
equilibrium quantity.

Putting the supply and demand curves from the previous sections together. These two
curves will intersect at Price = $6, and Quantity = 20.

In this market, the equilibrium price is $6 per unit, and equilibrium quantity is 20 units.

At this price level, market is in equilibrium. Quantity supplied is equal to quantity

demanded ( Qs = Qd).

Market is clear.
Q.10. Explain market surplus and shortage?

Ans If the market price is above the equilibrium price, quantity supplied is greater than
quantity demanded, creating a surplus. Market price will fall.

Example: if you are the producer, you have a lot of excess inventory that cannot sell.
Will you put them on sale? It is most likely yes. Once you lower the price of your
product, your product’s quantity demanded will rise until equilibrium is reached.
Therefore, surplus drives price down.

If the market price is below the equilibrium price, quantity supplied is less than quantity
demanded, creating a shortage. The market is not clear. It is in shortage. Market price
will rise because of this shortage.

Example: if you are the producer, your product is always out of stock. Will you raise the
price to make more profit? Most for-profit firms will say yes. Once you raise the price of
your product, your product’s quantity demanded will drop until equilibrium is reached.
Therefore, shortage drives price up.

If a surplus exist, price must fall in order to entice additional quantity demanded and
reduce quantity supplied until the surplus is eliminated. If a shortage exists, price must
rise in order to entice additional supply and reduce quantity demanded until the
shortage is eliminated.
Q.11. What is price floor?

Ans: Price Floor: is legally imposed minimum price on the market. Transactions below
this price is prohibited.

•Policy makers set floor price above the market equilibrium price which they believed is
too low.

•Price floors are most often placed on markets for goods that are an important source
of income for the sellers, such as labor market.

•Price floor generate surpluses on the market. •Example: minimum wage.

Q.12. What is Price Ceiling?

Ans: Price Ceiling: is legally imposed maximum price on the market. Transactions
above this price is prohibited.

•Policy makers set ceiling price below the market equilibrium price which they believed
is too high.

•Intention of price ceiling is keeping stuff affordable for poor people.

•Price ceiling generates shortages on the market. •Example: Rent control