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Tutorial week 2: Week 3

Demand and Supply equilibrium

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 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.

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(c) The prices of other grains rise. (d) Rice and potatoes fall in

Price Price
S2
S1 S1

P2
P1 P1

P2

D1 D2 D1

Q2 Q1 Quantity Q1 Q1 Quantity

price.

3. 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?

2
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

4. 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:

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400

360
S

320
Price ( per tonne)

280

240

200

160

120 D
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)

CASE STUDY- Read the following extracts and answer the questions below

BBC News online 5/08/2016

People spend more than a third of their disposable income on rent across large parts of England,
a BBC investigation has found.

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Analysis shows the average rent of a one-bedroom property in almost half of all districts, boroughs
and cities would cost more than 30% of the median take-home salary for the area.

The problem is most acute in London and the South East. The government said it was committed to
building more affordable homes.

BBC England's data unit analysed the average rents for different types of property in each local
authority area and the median weekly wage for those areas, using figures published by the Office for
National Statistics.

According to Shelter and the Joseph Rowntree Foundation, spending more than a third of your
disposable income on rent or a mortgage means you may not be able to afford other basic needs.

Based on average rents and median weekly wages, our investigation found:

Renting a studio flat exceeds 30% of take-home pay in every London borough except Bexley.
The cost of a studio exceeds 1,000 a month in Camden, Hackney, Islington, Kensington and
Chelsea, Southwark, Tower Hamlets and Westminster

Renting a room in a house or flat would swallow up more than 30% of the average
disposable income in 15 of London's 32 boroughs

It is impossible to rent a one, two or three bed property within the recommended limits
across the whole of the capital. In 24 London boroughs and the City of London, a one-
bedroom property would consume more than half your disposable income

The average cost of renting a room in a flat or a house in London is 607 a month, compared
to 424 across the South East

Average wages vs average rent

Experts say housing should cost no more than 30% of take home pay

30% of average monthly take home wage in England : 550

694-Average rent for one-bed flat

867 Average rent for three-bed home

760 Average rent for two-bed home

641 Average rent for a studio flat

382 Average rent for house share Source: Office for National Statistics

1. Using demand and supply diagrams, illustrate the situation in the rental market in the
capital.

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Price

S2

P2
P1

D2
D1
Q1 Q2 Quantity

2. Illustrate what would happen if more housing was built.

Price
S1
S2

P2

P1

D2
D1
Q1 Q2 Quantity