Question

Yesterday the price of a good was \(\$ 10,\) and the quantity demanded was 100 units. Today the price of the good is \(\$ 12\) and the quantity demanded is 87 units. Did quantity demanded fall because the price increased, or did the price rise because quantity demanded fell?

Short answer

Quantity demanded fell because the price increased.

Step-by-step solution

Understand the Situation

Two different situations are presented here: Yesterday, the price of a good was \(\$ 10\) and the quantity demanded was 100 units. Today, the price has risen to \(\$ 12\), and the quantity demanded decreased to 87 units.

Apply Economic Principle

In terms of Economics, people buy less of something if it's more expensive, given that all other factors remain equal. This is also known as the Demand Law.

Make Conclusion

Applying the Law of Demand to this scenario, it can be deduced that the quantity demanded fell because the price increased from \(\$10\) to \(\$12\), not the other way around.

Key concepts

Price Elasticity of Demand

Price elasticity of demand measures how the amount of goods demanded by consumers changes in response to a change in price. When the price of a product rises, and all other factors remain constant, we often see a decrease in demand. This is known as the Law of Demand.

To calculate the price elasticity of demand, we use the formula:

• \( \text{Price Elasticity of Demand} = \frac{\% \text{ Change in Quantity Demanded}}{\% \text{ Change in Price}} \)

If the resulting value is greater than 1, demand is considered elastic, meaning consumers are very responsive to price changes. If the value is less than 1, demand is inelastic, indicating consumers are less affected by price changes.

In the given exercise, as the price rose from \\(10 to \\)12, the quantity demanded fell from 100 to 87. The percentage change in price is \( \frac{12 - 10}{10} \times 100 = 20\% \) and the percentage change in quantity demanded is \( \frac{87 - 100}{100} \times 100 = -13\% \).

Plugging these into the formula gives us a price elasticity of demand of \( \frac{-13\%}{20\%} = -0.65 \). This shows that the demand is inelastic in this case, meaning demand does not proportionally decrease with a price increase.

Demand and Supply Analysis

To fully understand what's happening with demand and supply for the product, it's essential to analyze both factors. Demand refers to the quantity of a good that consumers are willing and able to purchase at various prices, while supply is the quantity that producers are willing to sell.

When analyzing demand:

• Consumer preferences, income levels, substitute goods, and complementary goods all affect how demand behaves.
• The Law of Demand suggests that an increase in price results in a decrease in quantity demanded, assuming all other factors remain constant.

On the supply side:

• Factors like production costs, technology, and the prices of related goods influence supply.
• The Law of Supply states that as the price of a good increases, the quantity supplied will usually increase as well.

In the exercise scenario, we observe that as the price increased, the demand decreased, adhering to the Law of Demand dynamics. Understanding these dynamics is crucial as they drive market behaviors and help predict future price movements.

Market Equilibrium

Market equilibrium is the point where the quantity demanded by consumers equals the quantity supplied by producers. At this point, there is no surplus or shortage in the market, and the market is said to be 'in balance.'

Equilibrium occurs at the intersection of the demand and supply curves. Changes in factors affecting demand or supply can shift these curves, leading to a new equilibrium price and quantity.

In the context of our exercise:

• The initial equilibrium was at a price of \\(10 with a quantity demanded of 100 units.
• A.price increase to \\)12 likely led to the new quantity demanded of 87 units.

This movement along the demand curve reflects a new temporary equilibrium based on current market conditions. Markets tend to adjust towards equilibrium due to these movements, illustrating the self-regulating nature of free markets.

Over time, if supply conditions remain the same and prices do not further increase, the market may settle at this new equilibrium. However, further changes in supply or external factors could shift the curves again, impacting both prices and quantities anew.