Question

Which of the following is an example of how supply affects price? A. Three new hospitals have opened in the city while healthcare costs continue to rise. B. During World War II, the U.S. government rationed sugar, meat, butter, and other commodities that had become scarce during war time. C. An exclusive luxury car must be preordered to the buyer’s specifications and can take up to eight weeks to manufacture and deliver. D. A bakery produced eight dozen cookies, but an hour before closing only 6.5 dozen had sold. The bakery offered the remaining cookies at half price.

Short answer

D. A bakery offered the remaining cookies at half price due to excess supply.

Step-by-step solution

Identify Key Concepts

Understand the relationship between 'supply' and 'price'. When supply increases, the price tends to decrease if demand remains constant. Similarly, when supply decreases, the price tends to increase if demand remains constant.

Analyze Option A

Three new hospitals have opened in the city while healthcare costs continue to rise. Analyze the relationship: Despite an increase in supply (hospitals), the prices (healthcare costs) are rising. This indicates that supply is not directly affecting the price here.

Analyze Option B

During World War II, the U.S. government rationed sugar, meat, butter, and other commodities that had become scarce during war time. Scarcity (decreased supply) would typically lead to higher prices, but this is more about rationing than observing a direct impact on price.

Analyze Option C

An exclusive luxury car must be preordered to the buyer’s specifications and can take up to eight weeks to manufacture and deliver. This option mentions delayed supply but does not directly indicate how the supply affects the price.

Analyze Option D

A bakery produced eight dozen cookies, but an hour before closing only 6.5 dozen had sold. The bakery offered the remaining cookies at half price. Here, we directly observe that excess supply (unsold cookies) leads to a price reduction (half price), exemplifying supply affecting price.

Determine the Correct Option

Based on the analyses, Option D clearly illustrates how an increase in supply (remaining cookies) leads to a decrease in price (half price), showing the direct impact of supply on price.

Key concepts

supply and demand

Supply and demand are fundamental economic concepts that describe the relationship between the amount of a good or service that producers are willing to sell and the amount that consumers are willing to buy at a given price. When supply increases and demand remains the same, prices tend to fall. Conversely, if supply decreases and demand remains constant, prices tend to rise.

It's essential to understand the dynamics of both supply and demand together because they jointly influence price levels and market equilibrium. For instance, if a bakery produces more cookies than consumers are willing to buy, the excess supply will likely result in lower prices. This illustrates the direct relationship between supply and the price mechanism.

The concept also works the other way around: when the demand increases and supply cannot keep up, prices go up. A good example of this would be limited edition sneakers, where a high demand with limited supply results in higher prices.

price determination

Price determination is the process by which the market price of a good or service is established. This process is influenced heavily by the forces of supply and demand. When the supply of a product is high but the demand is low, prices tend to decrease to entice more consumers to purchase the product. Conversely, when the supply is low and the demand is high, prices tend to increase.

For example, in our bakery case from the exercise, the unsold cookies represent higher supply than the demand, leading the bakery to lower the price to sell the remaining cookies. This scenario exemplifies how businesses have to adjust prices based on the supply levels to achieve a balance.

Price determination is crucial not just for individual businesses but for the entire economy. It dictates how resources are allocated and ensures that goods are distributed based on consumer preference and purchasing power.

economic principles

Economic principles are foundational guidelines that help explain how economies function and how various factors interrelate within an economic system. One of the key principles is the law of supply and demand, which we have already discussed. Another crucial principle is elasticity, which measures how sensitive the quantity demanded or supplied is to a change in price.

In the context of the bakery example, the principle of elasticity can explain why the bakery reduces its cookie prices when there are unsold cookies. If cookies are highly elastic (sensitive to price changes), a small reduction in price could significantly increase the quantity demanded.

Another important economic principle is the concept of opportunity cost, which represents the benefits one misses out on when choosing one alternative over another. In our exercise, if the bakery doesn't lower the cookie prices to sell the excess supply, it might face wastage, representing an opportunity cost.

Understanding these principles helps students and professionals make informed decisions, predict market trends, and optimize resources effectively.