Module II

EBC 101 / ECO 1: Introductory Economics
Module II: THE MARKET MECHANISM
SCOPE OF THE MODULE

This module consists of four lessons, namely:
Lesson 1 The Theory of Demand
Lesson 2 The Theory of Supply
Lesson 3 Market Equilibrium and Elasticity
Lesson 4 The Theory of Production and Cost
OVERVIEW OF THE MODULE

This module introduces you to the fundamental principles underlying
microeconomics - demand and supply analysis, elasticity, cost and production analysis -
in a market economy. The interaction between the households (demand) and the firms
(supply) creates a market situation, Price determination is based on cost. The
production cost is based on the quantity and quality of the various inputs (land, labor,
capital) used.
LEARNING OUTCOMES OF THE MODULE

At the end of this Module, the student should be able to:
1. plot and construct a graph showing a market situation (i.e., interaction
between demand and supply);
2. compute for the market equilibrium, given the demand, supply, production, or
cost equation; and
3. appraise the variables that affect supply, demand, production, and cost: after
which formulate the corresponding hypotheses.
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Thought Supplement:
Demand and Supply
Watch this video on the determinants of market buyers and sellers. What factors
affect their willingness to purchase and produce the goods?
https://www.youtube.com/watch?v=gdXoDkCfcM8&list=PL6B2DBE4C2FC8F845
Market Equilibrium
Observe the changes in the equilibrium price and quantity as demand and supply
curves shifts. Watch the video and analyze how the market experienced surplus
and shortage.
https://www.youtube.com/watch?v=V0tIOqU7m-c
Production Function
How is the Law of Diminishing Marginal Returns important in the short-run
production? Watch this video on how the firm can maximize factor inputs in
production.
https://www.youtube.com/watch?v=xLSRMt-wWAM
https://www.youtube.com/watch?v=UWImfFax8Ew
Elasticity
Buyers and Sellers react to changes in price of commodities, thus affect their
basket of goods. Watch these videos on computing and estimating
responsiveness.
https://www.youtube.com/watch?v=HHcblIxiAAk
https://www.youtube.com/watch?v=4oj_lnj6pXA
Market Equilibrium
Finding market equilibrium price and quantity using linear equations for demand
and supply Qd=Qs.
https://www.youtube.com/watch?v=vPRqJwjG8-Y
https://www.youtube.com/watch?v=9n-xMt-Sj3A
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MODULE II, LESSON 1: THEORY OF DEMAND
LESSON OUTCOMES:
At the end of the lesson, the student should be able to:
1. characterize and graph the law of demand;
2. differentiate the factors affecting the demand for a particular commodity; and
3. appraise how market factors affect the demand
INTRODUCTION:
It can be recalled that an economic system evolved out of a need to answer the
basic questions of what and how much to produce, for whom to produce, and how to
produce. In a market situation, buyers and sellers negotiate the exchange of a well-
defined commodity or service. What goods actually get produced depends in part upon
the willingness and ability of the producer to produce and sell as well as the willingness
and ability of the consumer to buy (helps to answer 'what and how to produce'). For
instance, if a buyer of a cloth thinks that the price is too high, he is not willing to pay for
the cloth. Conversely, if the supplier feels that the price is too low, he is not willing to
offer his cloth.
The resulting scarce goods are allocated to those who are willing and able to buy
them (helps to answer 'for whom'). Thus in a market economy, prices of goods and
services are determined by the interaction between supply and demand of goods and
services.
What is a good or a service? As we defined earlier, a "good "is a commodity that is
socially desirable, gives satisfaction so that consumers are willing to pay a price to get a
quantity of said commodity (e.g., clothes, automobile, food, etc.). A "service" refers to
any assistance extended to us by somebody whom we usually repay in monetary terms
(e.g., house repairs, food service, textbooks, and medical help). Price on the other hand
is the value of a product or service expressed in monetary units like "peso" and "dollar".
Goods and services arc being acquired by paying for them with money.
This module will explain the laws of demand and supply, the determination of price,
elasticities and the theory of production cost.
THEORY OF DEMAND
The concept of demand is utilized to represent the intention of a buyer in a market.

An individual or a household seeks to derive the greatest possible value from his
income for maximum satisfaction. Demand, therefore, expresses the willingness of a
consumer to buy goods or services at a given price level. Demand refers to the amount
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of food and services that households are willing to buy. It is also determined by other
factors like money, income, population, taste and preferences, price expectations and
prices of related goods (this will be discussed later).
ECONOMIC BEHAVIOR OF HOUSEHOLDS
Let us suppose that the table below (Table 1.1) represents your demand schedule
(quantity demanded for a particular commodity at different price levels) for mangoes.
Table 1.1: Demand Schedule for Mangoes
Quantity demanded (kilos) Price/kilo ( PhP )
0 20
1 18
2 16
2.5 15
3 14
4 12
5 10
At a price of PhP 18, you can only buy one kilo. If the price falls to PhP 14, what
happens to your willingness to buy? Of course, like any rational consumer, you would
want to buy more kilos (3 kilos) than when the price was at PhP 18 per kilo. So that the
lower the price, the higher becomes your willingness to buy more.
From the example above, we can see that the quantity demanded depends on the
price of the commodity.
In mathematical language, we can express our demand function as: Qd = f(P). If we
hold constant the other variables affecting demand (e.g., money income, population),
we would come up with a linear equation of the demand curve. With the use of the point
slope form equation of a line that you have learned in your College Algebra, the linear
equation of the demand curve can be derived as: Qd = d - mP
Where Qd = quantity demanded (in units)
d = intercept of the line or "autonomous demand where price
equals zero"
m = slope of the demand curve (rise/run)
P = market price of the commodity
The negative sign before the price factor denotes the negatively-sloped demand
curve and an inverse price-quantity demanded relationship.
Suppose now that you were given the demand equation for bananas as follows: Qd
= 100 - 10P. Using this equation, how can you complete this demand function? By
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substituting various prices of X into the demand function. Let us try to solve the first
case together.
If P = 2, then: Qd1=100 - 2 (P2)
Qd1 = 100 - 20
Qd1 = 80 kilos of bananas.
Go ahead and compute for Qd using same prices in Table 1.2. Practice your
algebra. Did you get the same result?
Table 1.2: Demand for Bananas
Price/kilo (P ) Quantity Demanded (Qd in kilos)
2 80
4 60
6 40
8 20
8.5 15
9 10
9.5 5
Before any further discussion, please do the following exercises.
Exercise 1.1: THE DEMAND SCHEDULE

Instruction: The table below depicts an individual firm's demand schedule for
commodity x. Complete the table based on the available information.
1. Given: Q = 1,000 – 10P
Price (P) in pesos 5 10 15 20 25

Quantity Demanded (Q)
2. From the results obtained in No. 1 above, how would you describe the
relationship between price and quantity demanded?
3. Considering that price (P) lies on the vertical axis, while quantity demanded (Q d )
on the horizontal axis, construct this individual firm's demand curve.
P
0 Qd
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Going back to our discussion, let us, refer to your demand schedule for mangoes
(see Table 1.1). If we plot each pair of values on a graph, we get your demand curve for
mangoes as shown in figure 1.1 below.
Figure 1.1: Demand Curve for Mangoes
20
18
16
14
12
10
P
8
6 A
4 B
2
0
0 1 2 3 4 5 6 7 8
Qd
The points on the demand curve represent your alternatives at a particular point in
time. If the price of mangoes is PhP 10 per kilo, you are willing to purchase 5 kilos. But
if the price goes up to PhP 16, then you will only buy 2 kilos of mangoes.
The inverse relationship between price and quantity is reflected in the negative slope
of the curve.
Exercise 1.2: THE SLOPE OF THE FIRM'S DEMAND CURVE

1. Hardcourt Manufacturing Co. is faced with a linear demand curve that follows
the Point-Slope Form type. The corporate planning department has represented the
demand equation to be: Q = a - mP, with a having a value of 75. From this brief
information, complete the demand schedule.

Quantity Demanded (Q) 66.65 41.6
THE LAW OF DEMAND
In the demand schedules (Table 1.1 and 1.2), we see that the lower the price, the
greater the quantity demanded by the individual. Consumers are most likely to buy more
goods and services as price decreases. The higher the price, the lesser the quantity
demanded for goods and services. Why is this so? Why the general tendency of the
consumer to buy more goods and services as price decreases? The reasons are very
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obvious. One, at lower prices, an individual has greater purchasing power. He can buy
more goods and services. But at higher prices, naturally he can buy less. For example,
the price of a 5 oz. bottle of Coke was only P2.50. With P10, how many can you buy?
You can buy 4 bottles of Coke. At present, the same P10 can purchase only 2 bottles of
Coke. This shows that the same amount of money income can buy more goods when
prices are lower, but lesser goods when prices are higher. This general tendency is
called the income effect.
The other explanation is due to the substitution effect. The tendency of consumers is
to buy goods with lower prices. In case if the price of the good that they are buying
increases, they look for substitutes whose prices are lower. For example, if the price of
Coke increases, consumers shift to other similar soft drinks with lower prices. This is the
reason why the rise in the price of a certain product reduces the quantity demanded for
such product.
With this, let us now define the Law of Demand. The Law of Demand states: "As
price increases, quantity demanded decreases, and as price decreases, quantity
demanded increases." This theory however is only true if the assumption of ceteris
paribus ("all other things equal or constant") is applied.
These "other things" are other determinants of demand like money income, tastes,
population, etc. For example, if the price of a TV set increases by 20%, then quantity
demanded for such good decreases. This is true if income of the buyer is the same. But
suppose income also increased by 100%, would quantity demanded for TV fall since
there is an increase in price? Of course not, because the income of the consumer has
increased. He has more purchasing power.
OTHER FACTORS AFFECTING DEMAND

(Determinants of Demand)
So far we have just seen how the price of a commodity affects the demand. In this
lesson, we will learn of the other factors, other than price, which are thought to affect the
quantity of a commodity demanded. These are income, population, tastes and
preferences, price expectation and prices of related goods. Let us discuss each, and
see how it affects the demand of a commodity.
Income: When income increases, people buy more goods and services. On the
other hand, when income decreases, demand for such goods also decline. Thus
changes in income likewise change the demand for goods and services.
Population: More people means more demand for goods and services. Conversely,
less population means less demand for goods and services. For example, there is less
demand for goods/ services in the rural areas than in the cities.
Tastes and preferences: When people like or prefer a good over another, demand
for it will be high. Otherwise, demand for it falls.
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Price Expectation: If people expect the prices of goods especially basic
commodities like rice, soap, oil to increase by the coming week, they buy more of these
goods. In the same manner, they decrease their demand for such products if they
expect prices to decline by next week or move tomorrow.
Prices of Related Goods: When the price of a certain good increases, people tend
to buy a substitute product. For example, if the price of Tide bar increases, consumers
will buy less of Tide and more of its close substitute like Ajax or Mr. Clean. This means
that the demand for Tide decreases while the demand for the other competitor
increases. Conversely, if the price of Tide bar decreases, the demand for it increases
while demand for the other competitor's product decreases.
In the case of complimentary products (products that go together) like coffee and
sugar or a bow and arrow, the price of one good and the demand for the other good is
directly opposite. This means if the price of one good increase, say a bow, the demand
for the other good, in this case an arrow, decreases.
For independent goods (goods that are not related), the change in the price of one
has little or no effect on the demand for the other. Examples are books and flowers.
How does this affect our demand curve? It can be recalled that if the price of a
commodity is changed and the other variables are held constant (ceteris paribus), the
quantity sought by the buyer changes inversely. As price changes, the whole demand
curve experiences a movement along the said curve.
Movement along the demand curve (caused by the price changes only), is called a
change in quantity demanded. When one or more of the other factors change (except
price), there is a change in demand. Graphically, this change in demand would shift the
entire demand curve to the left or to the right.
P Increase in P Decrease in
demand demand
D2 D1
D1 D2
Qd Qd
A shift to the right means an increase in the entire industry demand while a
shift to the left means a decrease in the entire demand.
When does the demand curve shift to the left?
Situation 1: Mang Pedring was laid off last week because of the firm's shutdown. If
he cannot find another job in the near future, his take-home pay would
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be decreased. Hence, there will be a decrease in his capacity to buy
some things for his family needs.
Situation 2: During summertime, the students in the cities go home to their
provinces. Hence no traffic congestion is felt in the cities.
Situation 3: Teenagers today prefer to use acid-washed than faded blue jeans.
Hence, there will be a decrease in the demand for faded blue jeans.
Situation 4: Nenita uses one Safeguard soap bar a week. However, this morning,
she was surprised that the price of one Ivory soap bar decreased by
15%. She decided to shift to the new brand.
Situation 5: Government imposed a total log ban starting this year. Because of this,
the bed factories foresee a possible slowdown in the business, and
therefore, increase in prices until they get a replacement for the wood
frames of their beds.
In summary, change in quantity demanded is influenced only by the price of the
good demanded while change in demand (shift of the demand curve) is influenced by
other determinants. These are the following movements of demand:
Decrease (shift to the left) if: Increase (shift to the right) if:
1. price of substitute good falls 1. price of substitute good rises
2. price of complimentary good rises 2. price of complimentary good decreases
3. expectation of price decrease 3. expectation of price increase
4. decrease in consumers income 4. increase in buyers income
5. low taste/preference on the good 5. like the good demanded
6. decrease number of consumers 6. increase number of consumers
In a capsule form, we can hypothesize that the demand curve for the products
mentioned in the five situations above will be shifts to the left caused by a fall in income
(situation 1), a decrease in population (situation 2), a distaste in the commodity
(situation 3), a decrease in the price of a substitute (situation 4), an increase in the price
of a complement (situation 5). Otherwise, an increase in income and population,
preference for the commodity, an increase in the price of a substitute and a decrease in
the price of a complement would result in a shift of the entire demand curve to the right.
THE MARKET DEMAND FOR A COMMODITY
We know how to estimate the individual's demand. But how can we determine the
market demand? Since we wish to explore the market behavior, it is necessary to
aggregate the demand schedule for all the buyers in a particular market to obtain a
market demand for the item.
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The market or aggregate demand for a commodity gives the alternative amounts of
the commodity demanded per time period, at various alternative prices, by all the
individuals in the market. The market demand for a commodity thus depends on all the
factors that determine the individual's demand, and in addition, on the number of buyers
of the commodity in the market. Geometrically, the market demand curve for a
commodity is obtained by the horizontal summation of all the individual's demand
curves for the commodity.
To illustrate the above situation, consider a market composed of two buyers, Maria
and Juan. Their individual demand curve for bananas is shown in figure 1.4a and 1.4b
respectively.
Figure 1.4a: Maria’s Demand Curve for Figure 1.4b: Juan’s Demand Curve for
Bananas Bananas
15 15
10 10
P P
5 5
0 0
0 5 10 15 0 5 10 15
The market demand curve shown in figure 1.4c is the horizontal addition of the two
individual curves of Maria (Fig. 1.4a) and Juan (Fig. 1.4b).
Figure 1.4c: Market Demand for Bananas

(Juna and Maria)
30
20
10
0
5 10 15
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Let us pause for a while and reinforce your understanding of the market demand
curve. Accomplish Exercise 1.4 and then proceed in answering the Self-Progress Check
Test of this Lesson.
Exercise 1.4: MARKET DEMAND CURVE

1. Derive a market demand schedule from the following information.
Consumer A Consumer B
Price/unit Market Demand
Quantity/Month Quantity/Month
20 0 0
15 5 5
10 10 10
5 15 15
2. Derive the market demand curve graphically.

P
0 Qd
3. Express the demand equation of Consumer A, Consumer B and the market demand.
QA =
QB =
QM =
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EBC 101 / ECO 1, Module 2, Lesson 1
SELF-PROGRESS CHECK TEST
Test I. Multiple Choice

_____ 1. Assume the demand schedule for C is downward-sloping. If the price of C
falls from P2.00 to P 1.75:
a. the demand of C will fall.
b. the demand of C will rise.
c. a large quantity of C will be demanded.
_____ 2. Which of the following will not cause the demand for product K to change:
a. change in consumer tastes.
b. change in the price of K.
c. increase in consumer Y.
_____ 3. The law of demand states that:
a. price and quantity are directly related.
b. the larger the number of buyers in a market, the lower will be the
product price.
c. price and quantity are inversely related.
_____ 4. Phonographs and records are:
a. independent goods.
b. substitute goods.
c. complement goods.
_____ 5. If the demand curve for product B increase as the price of product A
declines, it can be concluded that:
a. A and B are substitute goods.
b. A and B are complementary goods.
c. Both A and B are inferior goods.
_____ 6. If the price of product L increase, the demand curve for close substitute
product M will:
a. shift to the right.
b. shift to the left.
c. shift downward toward the horizontal axis.
_____ 7. If the price of K declines, the demand curve for the complementary
a. remain unchanged
b. shift to the right
c. decreases
_____ 8. Which of the following statements is correct?
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a. The decline in the price of X will increase the demand for substitute
product Y.
b. The increase in Y will reduce the demand for a normal good.
c. The increase in the price of C will decrease the demand for
complementary product D.
_____ 9. Which of the following is not a property of the demand curve?
a. a shift in the curve when one of the ceteris paburis variables change
b. an inverse relationship between price and quantity
c. a positive slope
_____ 10. When the economist says that demand or a product has increased, he
means that:
a. demand curve has shifted to the left
b. the product has become particularly scarce
c. consumers are now willing to purchase more of this product at each
possible price
_____ 11. If L and M are complementary goods, an increase in the price of L will
result in:
a. an increase in the price of M
b. an increase in the sales of M
c. a decrease in the sales of M
_____ 12. Which of the following will cause the demand curve for product A to shift to
the left?
a. an increase in the price of substitute product B.
b. an increase in money income if A is an inferior good.
c. a decrease in the price of complementary product C.
_____ 13. In a market environment, prices serve as high quality summary bits of
information. The information conveyed by a change in price:
a. indicates the relative scarcity of the good or service in question
b. acts as a signal to resource owners, telling them where their resources
can be most profitably employed
c. rations the good among all various claimant for that good
d. all of the above
_____ 14. The law of demand states that the quantity demanded of any good is:
a. directly related to its price.
b. inversely related to its price.
c. conversely related to its price.
d. indirectly related to its price.
_____ 15. The law of demand suggests that if the price of new Ford Mustangs
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increases,
a. more Mustangs will be produced.
b. fewer Mustangs will be sold.
c. the price of Chevrolet Camaros will remain the same.
d. none of the above.
_____ 16. Which of the following will not affect an individual's demand curve?
a. a shortage
b. expectations about future income
c. tastes and preferences
d. time
_____ 17. Which of the following will cause a decrease in the market demand for
pork?
a. an increase in the price of beef
b. a decrease in the price of pork
c. a decrease in the price of beef
d. an increase in the price of pork
_____ 18. Which of the following will cause an increase in the demand for butter?
a. a decrease in the price of butter
b. an increase in the price of bread
c. a decrease in the demand for jelly
d. an increase in the price of margarine
_____ 19. If the price of IBM personal computers falls from P28,000 to P21,000 and,
as a result, the number of personal computers purchased increases, then:
a. an increase in demand has occurred.
b. a leftward shift of the demand curve will result.
c. there has been an increase in the quantity demanded.
d. there has been a decrease in demand.
_____ 20. In economics, an inferior good is a good:
a. whose demand decreases when income increases.
b. that consumers do not decline.
c. that is of low quality.
d. all of the above.
_____ 21. If an increase in the price of A causes an increase in the demand for B, A
and B are:
a. substitutes
b. complements
c. normal goods
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d. inferior goods
_____ 22. As the price of A rises, the demand for B falls. Goods A and B are:
a. unrelated
b. complements
c. substitutes
d. inferior
_____ 23. If good X and good Y are substitutes, then an increase in the price of good
Y will cause:
a. the demand for good Y to fall
b. the demand for good X to fall
c. the price of good X to rise
d. the quantity demanded of goods Y to increase.
_____ 24. If hot dogs and hot dog rolls are complementary goods, then an increase
in the price of hot dog rolls would:
a. cause the demand curve for hot dogs to shift to the right.
b. cause consumers to slide down the demand curve for hot dogs and
increase the quantity demanded.
c. cause the demand curve for hot dogs to shift to the left.
d. cause consumers to slide up the demand curve for hot dogs and
decrease the quantity demanded.
_____ 25. Coke and Pepsi are substitute goods. This means that a reduction in the
price of Coke would:
a. increase the demand for Coke
b. decrease the demand for Pepsi
c. increase the demand for Pepsi,
d. decrease the demand for Coke.
_____ 26. Which of the following most likely cause the demand for sugar to
increase?
a. a decrease in the price of NutraSweet, a substitute good.
b. a decrease in consumer prices.
c. a decrease in the price of sugar.
d. a decrease if the price of coffee, a complementary good.
_____ 27. The total market demand curve:
a. is derived from the horizontal summation of all the individual demands
at a given price.
b. is derived from the vertical summation of all the individual demands at
a given price.
c. is derived from the horizontal summation of all the individual demands
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at a given quantity.
d. is unrelated to individual demand curves.
Test II. THEORY OF DEMAND: Slope Determination

Let us assume that the demand curve facing Atlas Enterprises is depicted by the
equation: Q = a - mP . If demand for the company's product at a zero price level is 100
units, complete the table below and determine the company's demand schedule.
Price ( P ) 60 80
Quantity Demanded ( Q ) 80 60
Test III.
1. If you were one of the economist of Company A and was given by management an
equation portraying the behavior of demand of one of the said company's product
line as follows: Qd = 80 - 2P. With the equation above, you are then asked to
complete their partial demand schedule given below.
Price (P) 8 9 10 11 12
Quantity Demanded (Q) 62
2. From the table you have completed, answer the following questions:
a. For every peso increase in price, quantity demanded (increases, decreases) by
_____ units.
b. The schedule above depicts a (direct, inverse) relationship between price and
quantity demanded.
c. The slope of this demand is equation is _____ (quantify).
Test IV.
Given a demand curve for the Market Demand for Pork, what will be the market demand
curve changes or quality demanded changes if the following situations will occur:
a. There is an increase in the price of substitute goods (poultry/chicken meat).
b. There is a decrease in the number of hog meat buyers.
Show your answer in a graph and explain the shift from left to right or from right to left.
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MODULE II, LESSON 2: THE THEORY OF SUPPLY
LESSON OUTCOMES:
At the end of the lesson, the student is expected to
1. characterize and graph the Law of Supply;
2. differentiate the factors that affect the supply of a particular commodity; and
3. explain how market factors affect the supply.
INTRODUCTION
In the previous lesson, we have discussed the role of demand in price determination
in a market economy. In this lesson, we concentrate on the role of supply.
Supply is a reflection of the choice of the seller, the producer of the goods and
services being bought by the households in the market. The theory of supply depicts the
behavior of the firm in the market. The firm seeks to use the best possible production
techniques available to him at the least cost level for maximum profit. Supply, therefore,
expresses the willingness of a firm to produce/sell goods and services at different price
levels. Quantity supplied refers to the amount of goods and services that producers are
willing to sell, given a stated price level. Supply, aside from price, is also determined by
technology, cost of production, number of sellers, prices of other goods price
expectations, taxes and subsidies (this will be discussed later).
ECONOMIC BEHAVIOR OF SUPPLIER
Let us suppose Mr. de la Cruz, a. fruit stand owner, wants to sell yellow mangoes in
the DC markets. His supply schedule is summarized in Table 2.1.
Table 2.1: Supply Schedule for Mangoes
Quality Supplied (in kilos) Price per Kilo
5 20
4 18
3 16
2 14
1 12
0 10
Can you see a pattern? What happens to his willingness to sell when the market
price per kilo goes up? As the selling price of mangoes increase, Mr. de la Cruz's
willingness to supply the market also increases. But as the demand decreases the
selling market also decreases. Price and quantity supplied are directly related. The
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behavior of the seller is predominantly termed as the theory of supply.
In the mathematical language, quantity supplied depends on the price of the
commodity. We can express our supply equation as Qs f(P). Holding constant the other
variables affecting supply (e.g., technology, cost of production), we would come up with
a linear equation of the supply curve. With the use of the point slope form equation of a
line that you have learned in your demand equation (Lesson 1), the linear equation of
the supply curve can be derived as:
Qs = s + nP
where Qs = quantity supplied
P = selling price of a commodity
S = supply intercept or "autonomous supply" or Q level where price
equals to zero (P= 0)
N = slope of the supply curve.
It should be emphasized that the positive sign before the price factor denotes the
positively sloped supply curve and a direct price-quantity supplied relationship.
Let us suppose that you were given the supply equation for banana as follows. Qs =
30 + 5P.
If you were given, too, a set of prices for banana over the past 7 periods, can you
determine the quantity supplied to complete the supply schedule in Table 2.2?
Table 2.2: Supply Schedule of Banana
Period Price per Kilo Quantity Supplied in Kilos
1 2.00 40
2 4.00 50
3 6.00 60
4 8.00 70
5 8.50 72.5
6 9.00 75
7 9.50 77.5
How? Simply substitute the corresponding prices to the supply equation and you will
be able to get the supply level at each price. Let us try the last case together.
Qs7 = 30 + 5(P9.50) = 30 + 47.5 = 77.5 kilos of bananas
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If we plot each pair of values on a graph, we will have the demand curve as shown
in Figure 2.1.
Figure 2.1: Supply Curve for Mangoes
20
18
16
P 14
12
10
8
0 1 2 3 4 5
The points on the supply curve represent alternatives as seen by the supplier at a
particular point in time. If the price of mangoes is P12 per kilo, the individual supplier is
willing to sell only 1 kilo. If the price goes up to P16, the supplier will sell 3 kilos.
The positive relationship between price and quantity supplied is reflected in the
positive slope of the curve.
Exercise 2.1
1. Given the supply equation to be: S = 1,000 + 50 P, find the quantity supplied by the
manufacturer at the respective price levels given below and complete the table.
Price (P) 10 11 12 13 14
Quantity (Q)
2. If the prevailing price of commodity A is P90, it was estimated that 6,018.90 units
were willingly supplied by the manufacturers. The company economist also
estimated the supply intercept to be 98.70. Assuming the company's supply curve is
linear, find the slope of this company's supply curve.
3. Complete the supply schedule below.
Price ( P) 90 110 130
Quantity (Q) 6018.9 7334.5
54
THE LAW OF SUPPLY
In the supply schedules (Table 2.1 and 2.2), we see that the higher the price, the
greater the quantity supplied by the individual producer. Suppliers tend to produce more
goods and services if the price increases. The lower the price, the lesser the quantity
supplied. Why is this so? The Law of Supply tells us that the general behavior of a
producer is to produce and offer more goods at higher price than at a lower price. The
reason: At higher prices sellers make more profit and more profits create more goods.
With this, let us now define the Law of Supply. The Law of Supply states: "As price
increases, quantity supplied also increases, and as price decreases, quantity supplied
also decreases." This theory however is only true if the assumption of ceteris_paribus
("all other things equal or constant") is applied.
These "other things" are other determinants of supply like cost of production,
technology, etc. These are illustrations:
Market price P25

Cost of production 15
Profit P10
If price increases from P25 to P30 and cost of production remains the same, the
producer gets more profit. Therefore, he is stimulated to produce more. To illustrate:
Market price P30

Cost of production 15
Profit P15
However, supposing price increases from P25 to P30 and the cost of production also
increases from P15 to P20, would the producer increase his quantity supplied? No,
because he gets no additional profit! Thus the Law of Supply does not apply in this
particular example since the cost of production has changed. If cost of production did
not change, the producer would get a P15 profit. And this encourages him to produce
more goods.
OTHER FACTORS AFFECTING SUPPLY
So far, we have just seen how the price of a commodity affects its supply. Other than
price, there are a set of influences (factors) which are thought to affect the quantity of a
commodity supplied. These are technology, cost of production, prices of other goods,
price expectations, etc. Let us explain each and see how they affect supply.
Technology. This refers to the methods of production. Modern technology increases
supply of goods. It tends to make possible for a firm to produce more and better
55
commodities with the same resources.
Cost of production. In producing goods, raw materials, labor, and capital are
needed. If the price of these factors of production (raw materials, labor, capital)
increases, it means higher cost of production. Profitability of the business decreases
(this is not what the suppliers want). And the producers have alternative (if they cannot
reduce their cost of production) except to cut down production or stop operations.
Price expectations. If producers expect prices to rise very soon, usually they keep
their goods and release them in the market when the prices are already high. This
creates artificial shortage due to hoarding.
An expected price increase encourages suppliers (factories) to produce more. This
is because of higher possibilities of profit.
How do these affect our supply curve? It can be recalled that if the price of a
commodity is changed, and the other variables are held constant (ceteris paribus), the
quantity sold by producers change directly. As the selling price changes, the whole
supply curve experiences a movement along said curve. An example is shown in Fig.
2.1 (recopied below). Notice that as the selling price changes from P1 to P2, the
movement would be along said curve, from point A to point B, or vice versa.
Figure 2.1: Supply Curve for Mangoes
20
18
16
P 14
12
10
8
0 1 2 3 4 5
Movement along the supply curve (caused by price changes only), is called a
change in quantity supplies'.
56
However, when one or more of the other factors of supply (e.g., technology, cost of
production) change, there is a change in total supply. We call this a change in supply.
This change in supply would shift the entire supply curve to the left or to the right
P Figure 2.3a: Change in P Figure 2.3b: Change in

Supply (Shift to the right) Supply (Shift to the left)
S1 S2
S2 S1
Qs Qs
(Figure 2.3a and 2.3b).

A shift to the right means a wish to supply more at each price level. A shift to the left
means a wish to supply less at each price level.
In a capsule form, a rightward shift in the supply curve can be caused by some kind
of changes in technology, a decrease in the prices of the factors of production, expected
price increase. In contrast, a leftward shift in the supply curve can be caused by
outdated technical knowledge; increase in the price of factors of production and
expected reduction in the price of the commodity under consideration.
THE MARKET SUPPLY FOR A COMMODITY
We know how to estimate the individual producer's supply. But how can we
determine the market supply?
Since we wish to explore market behavior, it is necessary to aggregate the supply
schedule for all the vendors/sellers in the market area to obtain a market supply curve
for the item. Hence, a market supply curve relates the various quantities of an item that
all vendors/producers in the market are willing to sell at alternative prices.
Geometrically, the market supply curve for a commodity is obtained by the horizontal
summation of all the individual supply curves for the commodity.
To illustrate the above situation, consider a market composed of two identical
suppliers Pilar and Pedro. Their individual supply curves for bananas are shown in
Figures 2.4a and 2.4b respectively.
The market supply curve shown in Fig. 2.4c is the horizontal addition of the two
individual curves of Pilar (Fig. 2.4a) and Pedro (Fig. 2.4b).
57
Figure 2.4a: Supply Curve of Pilar Figure 2.4b: Supply Curve of Pedro
(for Bananas) (for Bananas)
10 10
8 8
6 6
P P
4 4
2 2
0 0
2 4 6 8 2 4 6 8
Figure 2.4c: Market Supply for Bananas
10
6
P
4
0
0 2 4 6 8 10 12 14 16
Qs
58
Test I. Matching Type

Column A Column B
_____ 1. ceteris paribus a. excess supply
_____ 2. amount actually bought and sold b. quantity supplied
_____ 3. excess demand c. quantity exchanged
_____ 4. results of “Law” supply d. ratio of two absolute prices
_____ 5. relative price e. results of “law” of supply and

demand
_____ 6. cause of a shift supply
f. cause of a change in mind
_____ 7. an increase in population
g. change in technology
_____ 8. desired sales
h. holding all other variables
_____ 9. the fall in equilibrium price and constant
quantity following an increase in
supply i. greater quantity demanded
than quantity supplied at a
_____ 10. the disparity between quantities given price
demanded and supplied at a price
higher than equilibrium j. rise in equilibrium price and
quantity following an increase
in demand
Test II.
If the supply equation is: S = 88.786 + 781.34P, what is the quantity supplied given the
respective price levels below? Complete the supply schedule.
Price (P) 90.75 100.76 120.25 420.86 550.09
Quantity (Q)
59
Test III. Multiple Choice
_____ 1. The law of supply suggests that:
a. consumers will purchase more goods and services at low prices than
at high prices.
b. producers will supply a larger quantity of goods and services at high
prices than they will at low prices.
c. producers will supply a smaller quantity of goods and services at high
prices than they will at low prices.
_____ 2. The supply curve slopes upward to the right because:
a. the marginal opportunity cost of producing additional output eventually
rises.
b. the demand curve slopes downward and equilibrium requires that the
supply and demand curve cross.
c. once a cheaper production method is discovered, suppliers will adopt it
in an effort to stay competitive.
d. price and quantity supplied are inversely related.
_____ 3. A supply schedule:
a. is the time table that producers meet in supplying their customers
b. is the daily quota that is required of workers who are paid under a
“piecework” contract
c. provides an estimates of costs for a project yet to be undertaken, thus
providing a basis that allows a firm to bid on the project
d. shows the various quantities of a good the firm is willing o supply at
different prices.
_____ 4. When some variable other than price affects supply, it will be indicated by:
a. a larger quantity being supplied.
b. a movement along the supply curve.
c. a shift in the supply curve.
d. a smaller quantity being supplied.
_____ 5. Which of the following variables cannot cause the supply curve to shift?
a. a change in the cost of production.
b. a technological improvement.
c. the expectation of a future price increase
d. the price of the good.
_____ 6. An increase in the quantity supplied would be indicated by:
a. a movement along the supply curve.
b. a rightward shift of the supply curve.
c. a leftward shift of the supply curve.
60
d. a drop in the cost of production.
_____ 7. Supply depends on:
a. the cost of production.
b. technology.
c. the number of firms in the industry..
_____ 8. Which of the following cannot be responsible for the shift in the supply
curve?
a. a reduction in the price of the good.
b. a reduction in the cost of an input used in the production of the good.
c. an increase in the number of business firms in the industry.
d. an improvement in the technology of production.
_____ 9. Which of the following will cause the supply curve of luxury cars to the left
(change in supply)?
a. Increase in the number of sellers for luxury cars
b. Decrease on prices (factor inputs) producing luxury cars
c. Sellers expect that the price of luxury cars will increase next month
d. Improved technology used in producing luxury cars
_____ 10. Which of the following will shift the supply curve for palay rice to the right
(change in supply)?
a. Increase in price of corn rice
b. Decrease of subsidy/help from government on palay rice farms
c. Increase in number of farmers planting palay rice
d. Farmers used old/obsolete method in palay rice production
61
MODULE II, LESSON 3: MARKET EQUILIBRIUM AND ELASTICITY
LESSON OUTCOMES:
At the end of the lesson, the student is expected to:
1. delineate market equilibrium;
2. compare and contrast the concept of the Law of Supply and Demand;
3. determine the market equilibrium using a graph or through mathematical
computation;
4. apply the Law of Supply and Demand Concept to the economic behavior of
commodities;
5. appraise the relevance of the concept of elasticities; and
6. compute for the elasticities.
INTRODUCTION
In Lessons 1 and 2, we considered demand and supply separately. The question

that now confronts us is: how do these two forces interact to determine price in a
competitive market?
MARKET EQUILIBRIUM
Let's take a look again into Tables 1.1 (demand for mangoes) and 2.1 (supply of
mangoes). When both schedules are viewed together, as shown in Table 3.1, we have
a market situation.
Table 3.1: Market for Mangoes
Price per Kilo Quality Demanded (Qd) Quantity Supplied (Qs)
PhP 20 0 5
18 1 4
16 2 3
15 2.5 2.5
14 3 2
12 4 1
10 5 0
A market, therefore, consists of customers (buyers) and vendors (sellers) interacting

to determine the price of an item (in the above situation, mangoes) and the quantity
exchanged. In the process of interaction, a market reaches an equilibrium when the
62
quantity supplied (Qs) equals the quantity demanded (Qd) and no internal forces exist
to precipitate change. Using situation shown by Table 3.1, market equilibrium occurs
when Qs = Qd, when price level is PhP 15 per kilo.
Graphically, market equilibrium occurs at the price level where the supply and
demand curves intersect. In this intersection (Figure 3.1), the buying intentions of
buyers are consistent with the selling intentions of sellers. Therefore, PhP 15 is the
equilibrium price (Pe) and 2.5 kilos is the equilibrium quantity (Qe).
Figure 3.1: Market for Mangoes
20
19
18
17
16
Pe Market Equilibrium
P 15
Point (MPE)
14
13
12
Qe
11
10
0 0.5 1 1.5 2 2.5 3 3.5 4 4.5 5
Q
At prices, below the equilibrium, there will be shortages since demand is greater
than supply (D> S), and sooner prices will rise.
Until the MEP, there will be surpluses because suppliers are more willing to sell but
buyers would be less willing to demand for mangoes (S > D). When this happens, prices
would tend to fall until the equilibrium point is reached.
Mathematically, we can derive, too, the market equilibrium. Recall our demand
equation: Qd= d - mP while our supply equation is Qs = s + nP. The market equilibrium
point or MEP (defined as the point where demand is equal to supply) may be
determined by simply equating the demand equation and the supply equation. Hence,
we have: Qd = Qs. Hence, d - mP = s + nP. From this equation, the equilibrium price can
d s
be obtained: P 
n  m 
The corresponding equilibrium quantity may be determined by substituting the
equilibrium price on either the demand or supply equations given to you.
63
Let's illustrate the above idea by finding the MEP (P e) and Equilibrium Quantity (Qe)
using the data below.
Given: Qd = 1,000 - 40P
Qs = 600 + 50P
Solution: Qd = Qs
1,000 - 40P = 600 + 50P
1,000 - 600 = 50P + 40P
400 = 90P
400/90 = P
P = 4.44 pesos
Substituting the equilibrium price in either the demand or supply equation,
Using Demand: Using Supply:
Qd = 1000 - 40 (4.44) Qs = 600 + 50 (4.44)
= 822 units = 822 units
Using either the demand or supply equation will give us the same results.
After knowing how the equilibrium price is determined, let us now pause and define
the Law of Supply and Demand. According to this law, when the demand is greater than
the supply, price increase. When supply is equal to demand, price remains constant.
(This is the market price or the equilibrium level.)
Before we proceed to the next topic of this lesson, perform Exercise 3.1. Show your
solution/computations. When you finish, compare your final answers with the key at the
back.
Exercise 3.1: Determination of the Market Equilibrium Price and Quantity

Solve for the respective Pe and Qe per equation given. Encircle your final answers.
1. D = 6 – 3P; S = 2 + 2P
2. D = 89 – 9P; S = 20 + 22P
3. D = 1000 – 90P; S = 200 + 22P
4. D = 16 – 18P; S = 10 + 12P
5. D = 45.01 – 20.77P ; S = 11.99 + 12.65P
64
FLOOR AND CEILING PRICES
The discussion of supply and demand will not be complete if we fail to consider the
concept of price floors and price ceilings, as these two concepts are important in real
life, especially under the realm of government policy making.
A price floor (Pf) is the minimum price that a supplier could sell his product to the
consumers. This is normally set by the government, and has a bias towards suppliers of
commodities. The fundamental reason behind the imposition of a price floor may be
explained through the example below.
If the level of supply of sugar in the country exceeds the level of demand, it is
expected that the price of sugar in the market will go nowhere but down, following the
logic of supply and demand. If this goes on for a long period of time, then the sugar
farmers' income will suffer in due time. To protect the income of sugar farmers and
prevent it from deteriorating because of surplus production, the government imposes a
price floor, which in effect becomes the official selling price of sugar in the market.
Therefore, with the price floor, despite the overproduction which brings down the
equilibrium price of the commodity in the market, the price decline is cushioned by the
said floor price. The price floor is always above the equilibrium price.
A price ceiling (Pc) on the other hind is the Maximum price, that a manufacturer
would be able to sell his product to the consumers. If the price floor has a bias towards
suppliers, the price .ceiling has a bias towards consumers.
Price ceilings normally arise when there is an excess demand situation or when
there is low supply. If demand is greater than supply, just like our demand for
petroleum, then the government comes into the picture and imposes a price ceiling that
is the highest price that petroleum suppliers would sell their product in the market. By
doing so, consumer welfare is maximized and suppliers are prevented from taking
advantage of the situation by charging prices way above the equilibrium level. The
price ceiling is always below the equilibrium price.
Illustration: Figure 3.3
P
S>D
Pf
Pe MEP
Pc
D>S
65
Example:
It was determined that demand for rice was represented by the linear equation 1,000
- 90P. Because of the drought existing in the rice producing provinces of the country,
supply was approximately: 200 + 18P.
The National Food Authority (NFA) and the IRRI located at UP Los Baños feared
that because of the low supply level, prices of rice in the market might go up. The IRRI
and NFA also estimated that demand for rice will exceed the current output by 300
cavans (i.e. a shortage of 300 cavans) for the first quarter alone. If you were the
economist and you were asked to recommend to the President a certain price which will
protect consumers, will you recommend a price ceiling or a price floor? If so, how much
will that price be?
Solution:
From the problem it was clearly stated that demand will exceed supply by 300
cavans brought about by the drought prevailing in the provinces. Since the demand is
greater than the supply (D > S), you have to recommend a price ceiling, since it is
assumed that when D > S, prices will indeed increase way above the equilibrium price.
Therefore, to prevent them from doing just that, you implement a ceiling price.
In equation form: D – S = 300
1000 – 90P – (200 + 18P) = 300
1000 – 90P – 200 – 18P = 300
1000 – 200 – 90P – 18P = 300
800 – 108P = 300
800 – 300 = 108P
500/108 = P
4.62 = P
To get the equilibrium level, assuming there is no shortage we have: D=S
Therefore,
1000 - 90P = 200 + 18P
1000- 200 = 18P + 90P
Pe = 7.41
Notice that the said price ceiling of P 4.62 is below the equilibrium price level that
exists at PhP 7.41
MARKET ADJUSTMENTS
It can be recalled that changes or shifts in demand and supply occur when one of
the ceteris paribus variables change. In like manner, equilibrium prices and quantities
will change in response to shifts in both or either the supply or the demand curves.
66
Figure 3.4 a and b
P P
P2 P3
D2 D3
P1 P4
D1 D4
Q Q
Q1 Q2 Q4 Q3
An increase in demand (shift to the right) while supply remains constant, as shown in
(a) of Figure 3.4, increases price (P1 to P2) and quantity (Q1 to Q2) exchanged.
Inversely, a decrease in demand (shift to the left) while supply remains constant, as
shown in (b), decreases price (P3 to P4) and quantity (Q3 to Q4) exchanged.
Figure 3.5 c and d
P
S1 P
S4
P1
P4
S2 S3
P2 P3
D D
Q
Q
Q1 Q2 Q4 Q3
An increase in supply (shift to right) while demand remains constant, as shown in (c)
of Figure 3.5, decreases price (P1 to P2) and increases quantity (Q1 to Q2) exchanged.
Inversely, a decrease in supply (shift to left) while demand remains constant, as shown
in (d), increases price (P3 to P4) and decreases quantity (Q3 to Q4) exchanged.
When both the demand and supply curves shift simultaneously (as shown in Figures
3.6), the effect of price and quantity will depend upon the directions of the shift and their
relative magnitudes.
If both demand and supply shift right, the quantity increases, as shown in (e) of
Figure 3.6. If both curves experience a left shift, the quantity bought and sold
decreases. The change in price depends upon the relative magnitude of the shifts.
If supply and demand shift in opposite directions, as shown in (f), the price change
will be determined, but the change in quantity will depend upon the relative magnitude
of the shifts.
67
Figure 3.6 e and f
P
P
D S
S1 D2 D
P1
P1,2 D
D1 S2
P2
S
Q
Q
SQ1 SQ2 Q1 Q2
DQ1 DQ2
ELASTICITY
The shifting (to the left or to the right) of both the demand and supply curves, as
discussed in Section 3.3 of this module, show the direction of the changes in prices and
quantities exchanged. But by how much? In this section, we shall discuss how elasticity
measures the responsiveness of the quantity demanded to changes in one of the
variables (such as price and income) in a demand or supply function.
When the price of a kilo of rice increased in April this year by about 13%, the Filipino
consumer in both the rural and urban areas expressed dissatisfaction. In June, when
the price of gasoline per liter increased, too, by about 20% the business sector
expressed anger. Why? But will they still buy rice and gasoline? The answer is yes!
On the other hand, at about the same time, the price of a set of jade jewelry
increased by 10%; that of a bottle of Chivas Regal Whiskey increased by 5%. No
adverse reaction was heard from majority of the populace! Why? But will people buy
less sets of jade jewelry and Chivas Regal Whiskey at this time in as much as their
prices have increased in big percentages? Very positively!
In the above situations, a percentage change in the price of certain commodities
affect the people's degree of willingness to buy (sell), i.e., the degree of response on
quantity demanded (supplier). This response is measured by the so-called price
elasticity of demand (supply). If there is an increase in price, will people buy more or
less? Which has a greater change, that of price or that of quantity demanded
(supplied)? Hence, the price elasticity (Ep) of demand (or supply) shows a change
relative to the existing prices and quantities in the market. It is the percentage change in
quantity demanded (supplied) for a percentage change in price or Ep = % change in
quantity ÷ % change in price; where, the symbol Δ (delta) is used to represent a
change.
Q
Q Q P
Ep   x
P P Q
P
68
If the percentage change in price is greater than the percentage change in quantity
(% - P > % - Q); the price elasticity is said to be inelastic. This can be shown graphically
by a steeper-sloped demand curve as shown in Figure 3.7 (a) below. The steeper the
slope of the curve, the less elastic is the demand. Commodities like rice and gasoline
are usually price inelastic. No matter how high the price change is, people still buy these
goods because these are necessities or essentials.
Figure 3.7 a and b
P
P
P2
P2
P1 P1
Q Q
Q2 Q1 Q2 Q1
Inelastic Elastic
On the other hand, if the percentage change in price is lesser than the percentage
change in quantity (%ΔP < % ΔQ), the price elasticity is said to be elastic, as shown in
Figure 3.7(b). For a slight increase in the price of jewelries and/or imported liquors, for
example, people's willingness to buy would decline tremendously since these
commodities are considered non-essentials or luxury goods.
Algebraically, the critical value for price elasticity is one or unity. Economists classify
price elasticity coefficients depending upon whether the coefficient is greater than, equal
to, or less than one:
Price Elasticity Description Implications
>1 elastic %-Q>%-P
=1 unit elastic %-Q=%-P
<1 inelastic %-Q<%-P
An elasticity measure of 5, for example, implies that a 1% change in price will induce
a 5% change in quantity demanded. Hence, the commodity is considered as price
elastic. Nevertheless, an elasticity measure of .5 implies that a 1% change in price will
effect a 1/2% change in quantity demanded. Therefore, the product is considered as
price inelastic. What is the effect of price elasticity on total expenditure of the house-
holds? If elasticity of demand exceeds unity (elastic), a fall in price increases total
consumer expenditure, caused by an increase in quantity demanded or bought. A rise in
the price reduces the spending. If elasticity is less than unity (inelastic) a rise in price
increases total spending since one needs now additional money to buy the same
quantity of a product. A fall in the price decreases the spending.
69
What is the effect of price elasticity of demand-on total revenue of the firms? If E > 1
(elastic), a price reduction will increase total revenue since this induces buyers to buy.
Buyers (when E > 1) are price sensitive. But if E < 1 (inelastic), a decline in price will
only decrease total revenue. Buyers are not price sensitive.
In the above discussion, we have focused our attention on the effect of price
changes to changes in quantity demanded: Aside from price, income changes affect,
too, demand. Economists term the percentage change in quantity for a 1% change in
consumer income (Y) is the income elasticity of demand (Ey):
Q
Ey = % change in Q ÷ % change in y OR Q Q Y
Ey   x
Y Y Q
Y
As income changes, the reaction of demand changes, too. As income rises, the
consumer is assumed to become wealthy enough to begin to increase his demand for
most commodities aside from basic necessities (food and clothing). In developing
economies, for example, the demand for durable goods and services increases rapidly
as household income rises.
Income elasticities may be positive, zero, or negative and the signs are important in
the interpretation.
Income Elasticity Classification Interpretation
positive income - superior consumption of the good varies
with income (e.g., steak)
Zero income – dependent Consumption of the goods does
not vary with income (e.g., salt)
Negative Income - inferior consumption of the good varies
inversely with income (e.g., rice
soup/ lugaw
Through time, a good which is income - superior for the lower levels of income
classes become income - inferior as income rises.
Lastly, demand responds to changes in the prices of other goods. Good X may be a
substitute, a complement, or an independent of good Z. Substitutes are goods that
satisfy similar needs and may be used in place of one another. Complements are goods
that are usually used together or in conjunction with one another. Independents are
goods that are unrelated in consumption. The responsiveness of the quantity demanded
of Good X to changes in the price of another good such as Good Z is termed as the
cross elasticity of demand or.
Qx
Exz = to % change in Qx ÷ % in change in Pz OR Qx Qx Pz
E xz   x
Pz Pz Qx
Pz
70
The arithmetic sign of cross elasticity may be positive, zero, or negative, and the
sign is important in the interpretation.
Cross Elasticity Category of Good Interpretation
positive substitute goods are substitutes for one
another
zero independent goods are not related in
consumption
negative complements goods are consumed together
A cross elasticity of 2 for pork adobo and roast chicken indicates that as the price of
pork adobo increases by 1%, consumption of roast chicken increases by 2%. When the
cross elasticity is positive, the goods are substitutes.
A cross elasticity of 0 for lollipops and jeepneys indicates that the demand for
lollipops is unlikely to be influenced by the price of jeepneys.
Left-foot and right-foot sandals may be considered as close complements, since we
usually buy sandals in pairs. As the price of left-foot sandals increases, you will
probably purchase fewer sandals for your left-foot and fewer sandals for your right foot.
The cross elasticity will be negative.
The closer, therefore, is the relation of substitutability or complementarily, the larger
is the quantity reaction for any given price change, and thus the larger is the numerical
value of the cross-elasticity. If the two goods bear little relation to each other, we would
expect their cross-elasticities to be close to zero.
In this section of the module, we have discussed the 3 classifications of elasticity:
price elasticity of demand/supply, income elasticity of demand and cross elasticity.
(Let's stop for a moment and test your understanding on the above concepts by
performing Exercise 3.3 to follow. Show your computations. Then compare your
answers with the key at the back.)
Exercise 3.2: Elasticity Determination

Instructions: Given the following information, solve for the elasticity of demand. State
whether the demand is elastic, inelastic, or unitary.
Q1 Q2 % ΔQ P1 P2 % ΔP ED Category
100,000 300,000 _____ 1.00 .50 _____ _____ _____
200,000 300,000 _____ 75.00 25.00 _____ _____ _____
300,000 300,000 _____ 1.25 1.50 _____ _____ _____
100,000 105,000 _____ 65.00 25.00 _____ _____ _____
300,000 600,000 _____ 50.00 25.00 _____ _____ _____
71
Test I. Matching Type

Column A Column B
_____ 1. Inelastic demand a. positive cross elasticity of demand
_____ 2. Income elasticity of b. no change in revenue when price changes
demand
_____ 3. Infinite elasticity of c. change in quantity demanded from zero to an
demand indefinitely large amount with small price change.
_____ 4. Inferior goods d. negative income elasticity of demand
_____ 5. Goods in fixed supply e. negative cross elasticity of demand
_____ 6. Substitute goods f. percentage decrease in price greater than
percentage increase in quantity demanded
_____ 7. Complementary g. percentage change in quantity divided by
goods percentage change income.
_____ 8. Unit elasticity of h. zero elasticity of supply
demand
_____ 9. Independent goods i. no change in demand, the cross-elasticity is
zero
_____ 10. Elastic demand j. percentage decrease in price exceeds the
percentage increase in quantity demanded
Test II. Multiply Choice

_____ 1. Market is best described as:
a. a particular geographic location.
b. a large grocery store.
c. an area over which price tends towards equality.
d. a stock exchange.
_____ 2. Equilibrium is a situation in which:
a. there is enough of the good available for everyone to have an equal
share.
b. neither buyers nor sellers have any tendency to change their behavior.
c. consumers' wishes are satisfied, although some producers may be
dissatisfied with the outcome.
72
d. producers earn maximum profits.
_____ 3. A surplus will exist whenever:
a. producers bring less to market than consumers wish to purchase.
b. there are too many producers in the market.
c. price is above equilibrium.
d. the market price is prevented from rising to its equilibrium value.
_____ 4. At any price below the equilibrium price:
a. the quantity supplied exceeds the quantity demanded.
b. the quantity supplied is less than the quantity demanded.
c. the quantity supplied is equal to the quantity demanded.
d. additional suppliers will be attracted into the market.
_____ 5. A shortage:
a. can be prevented by allowing the price to fall.
b. results when the quantity demanded is less than the quantity supplied
at the prevailing price.
c. can only persist if price is prevented from performing its rationing
function.
d. illustrates that markets are unable to satisfy the needs of both
suppliers and demanders.
_____ 6. An effective price ceiling:
a. will result in a surplus.
b. will result in a shortage.
c. results in prices that are above equilibrium.
d. is the market response to the forces of supply and demand.
_____ 7. A price floor.
a. is the minimum price that producers will accept to supply a good or
service.
b. sets the price below equilibrium, resulting in a market shortage.
c. results from low-cost suppliers entering the market in an attempt to
drive out high-cost producers.
d. sets the price above equilibrium, resulting in a market surplus,
_____ 8. Shortage and surpluses can be prevented by:
a. allowing the market to respond to the forces of supply and demand.
b. allowing government to allocate the good to those who desire it most,
regardless of their ability to pay.
c. producers maintaining adequate supplies that allow them to adjust
quickly to changing circumstances.
73
_____ 9. If A and B are substitute goods, an increase in the price of A will cause the
demand curve for B to:
a. shift to the right, resulting in an increase in the equilibrium price and a
decrease in the equilibrium quantity.
b. shift to the left, resulting in a decrease in the equilibrium quantity.
c. shift to the left, resulting in an increase in the equilibrium quantity.
d. shift to the right, resulting in an increase in the equilibrium price and an
increase in the equilibrium quantity.
_____ 10. If A and B are complementary goods, a decrease in the price of A will
result in:
a. a decrease in the equilibrium price and quantity of B.
b. an increase in the equilibrium price and quantity of B.
c. a decrease in the equilibrium price and a decrease in the equilibrium
quantity of B.
d. an increase in the equilibrium price and a decrease in the equilibrium
quantity of B.
_____ 11. If X is an inferior good, an increase in consumer income will shift the
demand curve for X:
a. to the left and increase the equilibrium price.
b. to the right and increase the equilibrium price.
c. to the left and decrease the equilibrium price.
d. to the right and decrease the equilibrium price.
_____ 12. If diet soft drinks and non-diet soft drinks are substitutes for some people,
then a large increase in the price of sugar should:
a. increase the price of both the regular and the diet soft drinks.
b. increase the price of regular soft drinks, but have no effect on the diet
drinks.
c. increase the price of regular soft drinks and reduce the price of diet
soft drinks.
d. increase the price of diet soft drinks, but have no effect on the regular
soft drinks.
_____ 13. An increase in the price of a resource used in the production of good Y
would cause:
a. the demand curve for Y to shift to the left, resulting in a higher
equilibrium price and a lower equilibrium quantity.
b. the supply curve for Y to shift to the left, resulting in a higher
equilibrium price and a lower equilibrium quantity.
c. the supply curve for Y to shift to the right, resulting in a lower
74
equilibrium price and quantity.
d. the supply curve for y to shift to the left, resulting in a higher
equilibrium price and quantity.
_____ 14. An improvement in production technology will result in:
a. a lower equilibrium price and larger equilibrium quantity for a particular
good.
b. a lower equilibrium price and quantity for a particular good.
c. a higher equilibrium price and quantity for a particular good.
d. a higher equilibrium price and a smaller equilibrium quantity for a
particular good.
_____ 15. If the number of suppliers of a particular good increased, this would result
in:
a. a rightward shift in the supply curve and a decrease in the equilibrium
price.
b. a rightward shift in the supply curve and an increase in the equilibrium .
price
c. a leftward shift in the supply curve and a decrease in the equilibrium
price.
d. a rightward shift in the supply curve and an increase in the equilibrium
price.
_____ 16. The price elasticity of demand for a good is an attempt to measure:
a. consumer response to a price change.
b. the change in the amount purchased resulting. from a change in
consumer income.
c. the change in the price of a good resulting from a change in the cost of
production.
d. the variability of price (for any good) over a period of one year.
_____ 17. If large change in the price of a particular good causes a relatively small
change in the quantity
a. the demand for that good (for the price change given) is said to be
elastic.
b. the demand for that good (for the price change given) is said to be
inelastic.
c. it will be difficult to make a profit from the good.
d. we can conclude that consumers are not acting rationally, as defined
by economics.
_____ 18. The price elasticity of demand is computed by:
a. multiplying the price by the quantity purchased.
b. dividing the price by the quantity demanded.
75
c. dividing the percentage change in the amount purchased by the
percentage change in the price of the good.
d. averaging the effects of changes in the quantity demanded over an
extended interval of time.
_____ 19. When, t le price of Good X is cut in half, the amount purchased more than
doubles. The demand for Good X:
a. is elastic_
b. is inelastic.
c. is unitary (or unit) elastic.
_____ 20. The price of a particular style of shoes increased by 20 percent. One
month later, the number of pairs of this style of shoes purchased had
fallen by 15 percent. The one-month demand curve for this style of shoe
was:
a. income elastic.
b. price elastic.
c. income inelastic.
d. price inelastic.
_____ 21. When the price of movie tickets increases from P3 to P4 the number of
tickets sold decreases from 400 per week to 290 per week. The demand
curve for movie tickets, over the price range given, is:
a. inelastic.
b. unit elastic.
c. elastic.
d. not able to be determined from the information given.
_____ 22. Given the coefficient of elasticity of -0.4, if the price of all airline seats was
reduced by 50 percent, then the sale of seats would be expected to:
a. increase by 50 percent.
b. decrease by 50 percent.
c. increase by 200 percent.
d. decrease by 25 percent.
_____ 23. Suppose that you own a small grocery store. You have been selling a
particular brand of cola in 16-ounce bottles for P2.00 each. Your weekly
revenue from this cola has been about P400. You now increase the price
of this brand to P2.50, and your weekly income falls to P350. The demand
for this brand of cola is:
a. income elastic.
b. price elastic.
76
c. income inelastic.
d. price inelastic.
_____ 24. The short-run coefficient of elasticity for gasoline is likely to be:
a. greater than one.
b. equal to one.
c. less than one.
_____ 25. The income elasticity of demand defined as:
a. the percentage change in quantity demanded resulting from a given
percentage change in price.
b. the percentage change in income divided by the percentage change in
quantity demanded.
c. a rightward shift of the demand curve resulting from an income.
d. the percentage change in the amount purchased divided , by the
percentage change in income.
_____ 26. As a result of a pay raise of 12 percent, Mr. Sheldon increases his
expenditures on steak from P70 per week to P110 per week. Mr.
Sheldon's demand for beef is:
a. unresponsive to a change in income.
b. price elastic.
c. price inelastic.
d. income elastic.
_____ 27. The elasticity of supply is measured by:
a. multiplying the price by the quantity sold.
b. dividing the supply into the demand.
c. computing the ratio of price to quantity produced.
d. dividing the percentage change in quantity supplied by the percentage
change in price.
_____ 28. If the price of an item decreased by 5 percent, and this change resulted in
a decrease in the quantity supplied of 3 percent, we would say that the
elasticity of supply was:
a. inelastic.
b. elastic
c. related to the coefficient of demand.
d. more elastic in the short run than in the long run.
_____ 29. If the demand for a good is highly inelastic, the imposition of an excise tax
on that good:
a. permits the seller to pass most of the cost increase resulting from the
77
tax on the customer in the form of a higher price.
b. the burden of the tax is shared about equally between buyer s who
now pay a higher price and sellers who must now accept a smaller
profit.
c. causes the seller to bear most of the burden, since the demand does
not permit much of an increase in price.
d. will have none of the above effects.
_____ 30. The fact that both the demand for farm products and the supply of farm
products are relatively inelastic suggests that:
a. small changes in the size of the harvest will generate large changes in
prices and farm income.
b. small changes in the size of the harvest will generate small changes in
c. large changes in the size of the harvest will generate small changes in
d. small changes in price will bring large changes in the quantity supplied
and the quantity demanded.
Test III. True or False

_____ 1. "Surpluses drive prices up, shortages drive them down."
_____ 2. The equilibrium price is the price that clears the market, both excess
demand and excess supply are zero in equilibrium.
_____ 3. When the price is below the equilibrium price, quantity supplied exceeds
quantity demanded.
_____ 4. The price of a product will be established where the supply decisions of
producers and demand decisions of buyers are mutually consistent.
_____ 5. According to the law of supply and demand, an increase in demand
causes ceteris paribus, equilibrium price and quantity to fall.
_____ 6. Excess demand for a commodity is ordinarily eliminated through market
forces by price rising, quantity demanded decreasing and quantity
supplied increasing.
_____ 7. At equilibrium, the quantity demanded is equal to the quantity supplied.
_____ 8. The market clearing price is achieved when the quantity demanded is
greater than the quantity supplied.
_____ 9. If demand decreases and supply increases, equilibrium price will remain
unchanged.
_____ 10. If goods X and Y are complementary goods, an increase in the price of X
78
will, ceteris paribus, decrease the demand for Y.
Test IV. Market Adjustments.

Graph the following showing the changes in demand and supply given the following
situations (assumed that the changes of demand and supply are proportional).
A. Market for Luxury Cars
Price
S
per Unit
D
Quantity
Situation: Income of buyers willing to buy Luxury Cars increases while sellers used
improved technology in production.
B. Market for Palay
Price
S
per Unit
D
Quantity
Situation: There is increase in the number of farmlands for palay and no change in
the consumers demand for palay.
79
MODULE II, LESSON 4: THE THEORY OF PRODUCTION AND COST
LESSON OUTCOMES:
At the end of the lesson, the student is expected to:
1. distinguish the factors of production inputs;
2. give details the behavior of these factor inputs;
3. classify the factors affecting cost; and
4. explicate the behavior of these factor costs
INTRODUCTION
Lesson 2 of this module, it can be recalled, discussed the willingness of the producer
to supply a good or service at different price levels. A higher price level would motivate
him to increase production. But what would be the basis of this acceptable price level?
Naturally, that price level which would cover up his cost of producing a commodity and
an additional mark-up to satisfy his target profit. Production becomes operational once
the factors of production (which are land, labor, and capital) become available inputs to
produce a specific good or service needed by the growing population. But because of
the scarcity of our economic resources (which are also the inputs of production), the
function to produce involves an opportunity cost or a trade-off - how much of one good
or service must be given up to gain a certain quantity of another good or service. This
trade off determines the "acceptable" price level mentioned above Hence, production
and cost are interrelated, being two sides of one coin. Let's discuss the production side
of this coin.
THEORY OF PRODUCTION
The business firm organizes production. Producers choose the technology and the
quantities of inputs used to produce goods and services. Technology is society's
knowledge of production techniques. This knowledge includes the proportions in which
inputs may be combined to produce goods and the types of inputs that may be utilized
to produce a particular good. With its knowledge on the available quantity of these
factor inputs, the business sector can determine the production possibility levels that it
can perform to help sustain the needs of a growing population.
Total production or output (TP) depends on the quantities of the factor inputs. This
relationship is expressed in the production function: TP or output = f (units of labor,
capital, and natural resources)
An increase in inputs used would always increase output. Graphically, this positive
relationship between inputs and output can be seen in Figure 4.1
80
Figure 4.1
TP
Output
Input
The quantity of factor inputs utilized may be fixed (quantity does not vary with
output) or variable (quantity varies directly with output). Capital goods such as factory
buildings ad equipment may be fixed or invariant until they are replaced. Raw materials
and labor resources may be considered as variable inputs.
For example, the Agno Hydroelectric Plant has both fixed and variable inputs. The
dam across the Agno River is a fixed input; it cannot be removed instantly and remains
standing regardless of the output of electricity. The water falling through the turbines is
a variable input: the amount of electricity produced varies with the quantity of water.
More falling water means more electricity generated.
In the short run (during which at least one input is fixed), the production function with
a single variable input obeys the Law of Diminishing Returns. It holds that as a firm uses
more and more units of a variable input, while all the other factors remain constant
(ceteris paribus), the additional output of every new unit of output will be diminishing.
This behavior can be illustrated by the marginal product (MP) and average (AP) product
concepts, given the following production schedule (Table 4.1):
Table 4.1
Capital Labor Total Product Marginal Average
(K) (L) (TP or Q) Product (MP) Product (AP)
1 1 1 1.00 1.00
1 2 2 .50 1.00
1 4 3 .25 .75
1 8 4 .125 .50
1 16 5 .0625 .31
1 32 6 .19
It should be noted that input Capital (K) is fixed and input Labor (L) is variable. As
variable input Labor (L) increases, Total Product (TP) increases, too. But what about the
rate of increase? Look at the behavior of the MP. As input labor increases, MP of this
output decreases. The marginal product of an input is the change in total product for a
81
unit change in a variable (V) input. MP, therefore, measures the additional quantity
produced when an additional labor unit is used, where MP = (-)TP ÷ (-)Variable Input.
Using the above formula, compute for MP. Did you get the same result as that in the
schedule above? Next, look at the behavior of the AP As input Labor increases, AP of
TP2  TP1 dTP
MP  
V2  V1 dV
this input decreases. The average product is a measure of the output per unit of input.
To calculate AP, divide output (TP or Q) by the number of units of the variable input or
AP = TP ÷ Number of Variable Inputs.
Using the above formula, compute for the AP. Did you get the same results as that
in the schedule above? It should be stressed at this point that both MP and AP show
that the addition to total input from each additional unit of variable input diminishes.
Graphically, this "diminishing" behavior is shown in Figure 4.2 by the AP and MP
curves. It can be seen that the MP curve intersects the AP curve from above at the
maximum height of the AP curve.
Figure 4.2
0.875
0.75
A 0.625
P
0.5
M
P 0.375
0.25
0.125
0
0 4 8 12 16 20 24 28 32
Input Labor
(Try out Exercise 4.1. Use a graphing sheet to plot the necessary curves.)
82
Exercise 4.1
Consider the production schedule given below. Assume that input prices are
constant.
A. Compute the average and marginal product schedules for labor.
Capital Labor Output MP AP

50 0 0 __________ __________
50 1 20 __________ __________
50 2 50 __________ __________
50 3 75 __________ __________
50 4 95 __________ __________
50 5 110 __________ __________
50 6 120 __________ __________
50 7 125 __________ __________
50 8 125 __________ __________
50 9 120 __________ __________
50 10 115 __________ __________
B. Plot, in one graph, the TP curve and in another graph, MP and AP together.
C. Does this schedule exhibit diminishing returns? Why?
D. At what point will the MP and AP curves intersect?
In the first part of this lesson, we have seen the short run analysis of a firm's
production .given a single variable input. In the long run (during which period no input is
fixed), the production function follows the principle of returns to scale. All inputs or
factors of production are varied. It holds that as a firm changes (increase/decrease) all
its inputs, there is a proportionate change (increase/decrease) in output. There are
three possibilities:
Change in Output relative to
Returns to Scale
Proportionate Change in Inputs
(-) Output > (-) Inputs Increasing
(-) Output = (-) Inputs Constant
(-) Output < (-) Inputs Decreasing
An increasing return to scale or economies of scale happens when the proportionate

increase in output is greater than the increase in inputs because of division of labor and
83
specialization. As the firm's production expands, output increases faster than inputs so
that the cost per unit of output falls. Hence, a firm with increasing returns to scale is
called decreasing-cost firm.
When a firm experiences a proportionate rate of increase in both inputs and outputs,
it is said to have a constant return to scale. Hence, the firm is termed as constant cost
firm.
A decreasing return to scale or diseconomics of scale occur if total product
increases at a slower rate than the increase in inputs. Because of bigness of operations
in production, the difficulty in coordination and control may decrease efficiency. This
.situation may result in the expansion in output at a lesser pace than the expansion in
inputs. Hence, a firm with decreasing returns to scale is called a rising-cost firm.
At this point, it becomes obvious that in both the short-run and long-run periods, a
change (expansion/contraction) in output or production involves a cost. So that cost is
the basis of supply.
THEORY OF COST
Economic costs are the value to society of all resources used in the production of an
item. Economic costs may be explicit (or out-of-pocket) expenditures or implicit costs.
Explicit costs are the value of resources purchased for production. Implicit costs are the
value of self-owned resources utilized in production.
In this section, the concept of cost is limited to the firm's explicit costs in the
production process in a competitive market. What factors/ variables affect cost? The
quantity of the firm's input, the input prices, and the resulting output determine the firm's
cost function.
Cost = f ( no. of inputs, prices of inputs, output )
In the short run, explicit costs may be classified into variable cost and fixed cost.
Costs that vary with the volume of production (like direct labor and raw materials) are
called variable (or direct) costs while those that are relatively unchanging (like factory
rental and other overhead expenses) are called fixed (or overhead) costs. The sum of
variable cost (VC) and fixed cost (FC) is termed as total cost (TC).
TC = Variable Cost (VC) + Fixed Cost (FC)
FC = Price of fixed input per unit x Quantity of fixed input
VC = Price of variable input per unit x Quantity of variable input
For example, let's assume that capital (K) is a fixed input. The price of capital (P k) is
P5 per unit; the price of input labor (PL) is P10 per unit. Multiplying Pk and PL by the
amounts of capital and labor, respectively, given in the production schedule, we obtain
the fixed and variable cost schedules. Adding the fixed and variable costs for each
output gives the total cost schedule (refer to Table 4.2).
84
Table 4.2
Production Schedule Cost Schedule
Capital Labor Output Fixed Cost Variable Total Cost
(K) (L) (TP) (FC) Cost (VC) (TC)
10 0 0 50 0 50
10 1 5 50 10 60
10 2 12 50 20 70
10 3 18 50 30 80
10 4 23 50 40 90
10 5 27 50 50 100
10 6 30 50 60 110
10 7 32 50 70 120
10 8 33 50 80 130
Graphically, if we relate PC, VC, and TC to output (TP) and plot the schedule
together, then we obtain the cost curves as shown in Figure 4.3. One can observe that
TC and VC's behavior follows the Law of Diminishing Returns. As more outputs are
produced, cost also increases but at a diminishing rate.
Figure 4.3
TC
130
120
110
F 100
C 90
80 VC
T 70
C 60
FC
50
V 40
C 30
20
10
0
0 5 10 15 20 25 30 35
Q or TP
If we want, however, to prepare a more useful data needed in the analysis of profit
maximization or loss minimization, the unit cost curves are more useful in price and
85
output of determination than total cost curves.
Given the prices at which output can be sold, the firm can compare the per unit cost
against the per unit price. The most commonly used per unit costs are average costs
(average total cost or ATC, average fixed cost or AFC, average variable cost or AVC)
and marginal cost (MC). Average cost is the cost per unit of output.
AFC = Total FC ÷ Q or AFC = ATC - AVC
AVC = Total VC ÷ Q or AVC = ATC - AFC
ATC = Total Cost ÷ Q or ATC = AVC + AFC
On the other hand, marginal cost is the change in total cost for a unit change in
quantity. Therefore, MC is the additional cost for producing an additional output.
MC = (-) TC ÷ (-) Q or TC2  TC1 dTC

Q2  Q1 dQ
Given the same output schedule and C schedule in the previous page (Table 4.2),
we can compute for the ATC and MC curves (Table 4.3).
Table 4.3
Output Total Cost Average Total Cost Marginal Cost
(Q) (TC) (ATC) (MC)
0 50
5 60 2.00 2.00
12 70 5.10 1.43
18 80 4.44 1.67
23 90 3.91 2.00
27 100 3.70 2.50
30 110 3.67 3.33
32 120 3. 75 5.00
33 130 3.94 10.00
Solve on your own the AVC and AFC schedules. What do you notice in the above
schedules? As output increases, both the average cost (specifically ATC and AVC) and
marginal cost (MC) would start at a higher level, then slowly would decrease but would
eventually rise according to the Law of Diminishing Returns. But AFC would
continuously decline as output increases.
Graphically, the behavior of our ATC, AVC, and MC curves are U-shaped (as shown
in Figure 4.4). It should be observed that MC intersects AVC and ATC at their minimum
levels (points A and B respectively).
86
Figure 4.4
MC
10
9
A
8
T
C 7
6
A
5
V ATC
C 4
3
M
2
C
1 AVC
0
0 5 10 15 20 25 30 35
Q or TP
In summary, the following relationship among the ATC, AVC, and MC hold true:
If the AVC is decreasing, MC is less than AVC.
If the ATC is decreasing, MC is less than ATC.
If the AVC is increasing, MC is greater than AVC.
If the ATC is increasing, MC is greater than ATC.

If AVC = MC, AVC is at its minimum point.
If ATC = MC, ATC is at its minimum point.
When MC intersects with ATC (at point B), a firm is said to be operating on a
maximum profit level. Given the situation in Figure 4.4, when the firm produces 30 units
of output, it is said to be maximizing profit if the average cost is P3.67 per unit.
Producing more than 30 means lessening of extraordinary profits.
When MC intersects with AVC (at point A), a firm is said to be operating on a
minimum loss level. In figure 4.4 again, when the firm produces 18 units of output, it is
said to be minimizing his loss if the average cost is P1.67 per unit. Producing more than
18 units may result in the lessening of normal profits increasing the cost of production
and, therefore, operating on a shutdown level.
Once we have said that cost is the basis of supply. The supply curve of a firm merely
follows the MC curve, starting from the minimum point of the AVC. Using Figure 4.4, the
87
supply curve of the firm is ABMC.
In the long run, the average cost (LRAC) curve would be an envelope of a series of
short-run average cost (SRAC) curves (Figure 4.5). This curve can be determined
optimal output and plant size in the long run.
Figure .4.5
Input
LRAC Curve
We shall be discussing more of prices and output, cost and production within the
framework of different market structures in the next module (Module III).
(Let's pause for a moment and test your understanding on the above concepts by
answering Exercise 4.2. Show your computations.)
Exercise 4.2
A. Using the given production schedule below and input prices of Pk = P2 and PL =
P50, find the total fixed, total variable and total cost schedule.
Inputs
Output FC VC TC
Labor Capital
0 100 0 _____ _____ _____
1 100 30 _____ _____ _____
2 100 55 _____ _____ _____
3 100 75 _____ _____ _____
4 100 90 _____ _____ _____
5 100 100 _____ _____ _____
6 100 105 _____ _____ _____
88
B. Given the above cost schedules, find the average fixed costs, average variable
costs, average total costs, and marginal cost.
Output AFC AVC ATC MC

0 _____ _____ _____ _____
30 _____ _____ _____ _____
55 _____ _____ _____ _____
75 _____ _____ _____ _____
90 _____ _____ _____ _____
100 _____ _____ _____ _____
105 _____ _____ _____ _____
89
Test I. True or False

_____ 1. Diminishing returns permeate every facet of life.
_____ 2. A foregone opportunity is an implicit cost.
_____ 3. Sunk costs should be considered when making a current decision.
_____ 4. Implicit costs may exceed explicit costs.
_____ 5. Marginal cost equals the change in total revenue divided by the change in
output.
_____ 6. Marginal cost equals the change in total cost multiplied by the change in
output.
_____ 7. The marginal product of any variable resource equals the change in total
output divided by the change in the amount of that resource used.
_____ 8. Marginal cost at first rises, then falls.
_____ 9. If at some quantity the marginal benefits exceed the marginal costs of
acquiring some product, then the rational consumer will purchase that
quantity.
_____ 10. The law of diminishing returns explains why supply curves slope upward.
_____ 11. If marginal product is rising, then marginal costs are rising.
_____ 12. Marginal product is maximized at the output at which marginal costs are
maximized.
_____ 13. A market supply curve is derived by horizontally summing the upward
sloping portion of all firms marginal cost curves.
_____ 14. A firm is both a buyer and a seller but in different markets.
_____ 15. Economists assume firms attempt to maximize profits or minimize losses.
_____ 16. In the long run, fixed costs are zero.
_____ 17. All firms experience economies and diseconomies of scale to the same/
degree.
_____ 18. Marginal cost curve always interest the average variable cost and the
average total cost curves at their minimum points.
_____ 19. An increase in fixed costs will cause a firm to cut back on its output level.
_____ 20. The shape of the marginal cost, average total cost, and average variable
cost curves is determined by the law of diminishing returns.
_____ 21. AVC = ATC + AFC
_____ 22. All cost curves assume the most technically efficient use of resources.
90
_____ 23. If the marginal product of labor per last penny spent is greater for workers
than for machines, then the firm should employ more machines and fewer
workers.
_____ 24. If MPL/PL= MPk/Pk then the firm is minimizing the cost of producing that
output level
_____ 25. Marginal cost measures the amount incurred by the producers when
adding additional unit of a community in the production.
Test II. Matching Type

Column A Column B
_____ 1. Short run a. marginal cost
_____ 2. Hypothesis of eventual b. change in total product with an
decrease in marginal product increase of one unit of a variable
as units of the variable input
factors.
c. plant capacity
_____ 3. Very long run
d. period of the time over which some
_____ 4. Total fixed cost inputs cannot be varied.
_____ 5. Factors whose quantities may e. long run
be altered in the short run.
f. set of all technologically efficient
_____ 6. Production function
g. average fixed cost
_____ 7. Increase in total cost when
h. cost curve that is horizontal as
output increases by one unit.
output increases.
_____ 8. Variable costs
i. “ law of diminishing returns”
_____ 9. Marginal product
j. costs whose total changes with
_____ 10. Level of output of which short- output
run average total
k. variable factors as output
_____ 11. Cost curve that declines
l. period during which technology
_____ 12. Period of time in which all available to firm changes.
inputs can be varied.
m. the ratio of total cost, TC and
_____ 13. Economic production quantity, Q
_____ 14. The difference between n. an economic process where
average total cost and revenues, cost and profit can be
average fixed cost. measured
_____ 15. Average total cost, ATC o. average variable cost, AVC
91
Test III. Multiple Choice
_____ 1. What is the principal distinction between explicit costs and implicit costs?
a. implicit costs must be paid immediately, but explicit costs need only be
paid in the long run.
b. there is no real difference between explicit and implicit costs.
c. explicit costs are costs which must be paid for directly, while implicit
costs usually represent foregone opportunities.
d. implicit costs are usually larger than explicit costs.
_____ 2. In general accounting costs represent:
a. only explicit costs.
b. only implicit costs.
c. both explicit and implicit costs.
d. both private and social costs.
_____ 3. Which of the following best illustrates an implicit cost of home ownership?
a. paying your monthly mortgage payment by check rather than in cash.
b. maintenance and repair costs that arise suddenly and unexpectedly.
c. interest foregone on the down payment that you made when you
purchased the house.
d. property tax and insurance which pay in one lump sum annually.
_____ 4. Total production costs consist of:
a. average costs plus variable costs.
b. marginal costs plus sunk costs.
c. variable costs minus fixed costs.
d. explicit costs plus implicit costs.
_____ 5. A business firm will be earning economic profile if its total revenue
exceeds its:
a. total fixed costs.
b. total variable costs
c. average variable costs.
d. total costs, including a rate of return to the owner equal to his or her
next best opportunity.
_____ 6. In economics, the long run is considered to be a period of
a. at least six months.
b. time greater than five years.
c. time of sufficient length to require that implicit costs be taken into
account in the production process.
d. time of sufficient length to allow all factors of production to be varied.
92
_____ 7. In the short run, a firm will be able to:vary none of its factors of production.
a. vary none of its factors of production
b. vary all its factors of production.
c. vary some of its factors of production
d. none of the above
_____ 8. Which of the following represents an example of a long-run adjustment for
the owner of small hamburger stand?
a. having to hire additional counter help to reduce the length of the lines
that form each day at noon.
b. reducing the size of her regular monthly order of ground beef from her
supplier based on the decision to decrease the size of each
hamburger.
c. building an addition on the present structure to allow for expansion and
the utilization of the most modern restaurant equipment.
d. cutting her prices to match the price of the new hamburger chain
located down the block.
_____ 9. Average fixed costs:
a. remain constant as the level of output increases.
b. at first fall with rising output, but then, as diminishing return comes into
play, they will rise with additional output levels.
c. at first rise with rising output, but then as economies of scale come into
play, they will fall with additional output.
d. fall continuously as output is expanded.
_____ 10. Total fixed costs:
a. represent the implicit costs to the firm
b. will decline continuously as output is expanded
c. represent the sum of all implicit and explicit cost of production
d. do not vary with output
_____ 11. Marginal cost is defined as:
a. total cost is divided by quantity
b. the change in total cost resulting from the production of one additional
unit of output
c. total variable cost divided by the number of units produced
d. averaged fixed cost times the number of units produced
_____ 12. Marginal cost is:
a. directly related to the marginal product.
b. inversely related to the marginal product.
c. directly related to the total product.
93
d. inversely related to the total product.
_____ 13. A business firm will be earning an economic profit whenever:
a. total revenue exceeds total explicit costs.
b. price is less than average total costs but greater than marginal cost.
c. the market price exceeds average variable cost.
d. marginal cost intersects average total cost below the market price.
_____ 14. The Law of Diminishing Return implies that as additional units of a
variable input are combined with a fixed resource:
a. at some point output begins to decline.
b. total cost begins to rise.
c. at some point the additions to output begin to decline.
d. at some point average fixed cost begins to decline.
_____ 15. The shape of the total product curve:
a. reflects the fact that the last factors of production employed are not of
the same quality as those factors employed first.
b. is the result of the fact that in the long run the amount of all factors of
production employed by the firm can be varied.
c. reflects the eventually diminishing marginal returns to a variable factor
of production when it is combined with a fixed factor of production.
d. is the result of the fact that total fixed costs remain constant throughout
the entire range of production.
_____ 16. The fact that the law of diminishing returns eventually causes output to
increase at a diminishing rate suggests that:
a. attempts to keep output growing at a constant rate will become
increasingly costly to accomplish.
b. business firms never produce as much output as they would like to
produce.
c. it is impossible to increase the level of output beyond the first few units.
d. consumers value the last units of a product consumed less than they
value the first units consumed.
_____ 17. Only the construction of a new office building is completed, the resources
that went into its construction no longer have any alternative uses. Thus
the monthly mortgage payment being made by the owner represents, from
society's point of view, a sunk cost. However, from the owner's
perspective, the monthly mortgage payment represents:
a. part of his average variable costs of production.
b. his total resource costs for producing a given level of output.
c. a marginal cost that is necessary to retain possession of the office
94
building.
d. a sunk cost that he should ignore.
_____ 18. The relationship between cost curve and the average total cost curve is
such that: the marginal cost curve is always above the average total. If the
price of a resource requires in the production process should increase,
then:
a. the marginal cost curve would shift upward by the amount of the price
increase.
b. both the marginal cost curve and the average total cost curve would
shift upward the amount of the price increase.
c. the average total cost curve would shift upward by the amount of the
price increase.
d. neither the marginal nor the average total cost curve would be affected
by a change in a resource price.
_____ 19. Which of the following would cause a shift in the cost curve of a firm?
a. a change in the market price of the firm's output.
b. a change in the demand for the firm's output.
c. a change in the technology employed by the firm.
_____ 20. Which of the following is assumed to be fixed when the cost curves of a
firm are drawn?
a. technology
b. taxes
c. resource prices
d. all of the above
_____ 21. As a business increases its level of production, which of the following
cannot rise?
a. marginal cost
b. average total cost
c. average fixed cost
d. average variable cost
_____ 22. Government may be able to regulate the effects of negative externalities
by:
a. restricting production.
b. setting and enforcing standards of performance.
c. taxing firms generating the externalities.
_____ 23. Before a new plant is built, the relevant cost to consider in designing the
95
plant is:
a. the short-run average total cost curve.
b. the long-run average total 'cost curve.
c. the short-run average variable cost curve.
d. the long-run average fixed cost curve.
_____ 24. It is a production concept that refers to the cosdt incurred after adding
additional unit of output. It is measured by the ratio of the difference
between total cost and the difference between output.
a. implicit cost
b. Fixed cost
c. Explicit cost
d. marginal cost
_____ 25. Which of the following inputs van be considered a variable input for
Mapagmahal Business Farm-Palay Mill?
a. 3 hectares of palay farmland
b. 5 additional seasona;l farm workers
c. 2 units of milling equipment
d. 4 units of harvest tractors
96
EBC 101 / ECO 1, Module II
ANSWER KEYS TO THE EXERCISES AND SELF-PROGRESS CHECK TESTS
Lesson 1
Exercise 1 1
Quantity Demanded (Q) 950 900 850 800 750
Exercise 1.2
Price(1) 1 2 3 4 5
Quantity Demanded (QD) 66.65 58.30 49.95 41.6 33.25
Exercise 1.4
1)
Consumer A Consumer B
Price/unit Market Demand
Quantity/Mon. Quantity/Mon.
20 0 - 0
15 5 0 5
10 10 5 15
5 15 10 25
0 20 15 35
2)
20
15
P 10
0
0 5 10 15 20 25 30 35
Qd
3. QA = 20 – P; QB = 15 – P; QM = 35 - 2P
97
Test I
1. c 4. c 7. b 10. c 13. d 16. d 19. c 22. b 25. a
2. b 5. b 8. c 11. c 14. b 17. c 20. a 23. c 26. d
3. c 6. a 9. c 12. b 15. b 18. d 21. a 24. c 27. a
Test II.
P 40 50 60 70 80
Qd 80 75 70 65 60
Test III
1.
P 8 9 10 11 12
Qd 64 62 60 58 56
2. a. decreases; b. inverse; c. 2
Lesson 2
Exercise 2.1
1.
P 10 11 12 13 14
Q 1,500 1,550 1600 1,650 1,700
2. 6,018.90 = 98.70 + n(90) = 65.78

3.
Price(P) 90 100 110 120 130
Quantity(Q) 6018.94 6676.7 7.334.5 7992.3 8650.1
Test I
1. h 2. c 3. i 4. j 5. d 6. g 7. f 8. b 9. e 10. a
Test II
1.
Price(P) 90.75 100.76 120.25 420.86 550.09
Quantit 328.92 429.89
70.995 78.816 94.045
y(Q) 3 7
Test III
1. b 2. a 3. d 4. j 5. d 6. a 7. d 8. a
98
Lesson 3
Exercise 3.1
1. p = .80 Q = 3.6
2. p = 6.27 Q = 32.54
3. p = 19.97 Q = 639.34
4. p = 2 Q = 12.4
5. p = 9 Q = 24.54
Exercise 3.2
Q1 Q2 %∆Q P1 P2 %∆P ED Category
100,000.00 300,000.00 2 1.00 0.50 0.5 4 Elastic
200,000.00 300,000.00 0.5 75.00 25.00 0.67 0.75 Inelastic
300,000.00 300,000.00 0 1.25 1.50 -0.2 0 Inelastic
100,000.00 105,000.00 0.05 65 25.00 0.62 0.08 Inelastic
300,000.00 600,000.00 1 50 25.00 0.5 2 Elastic
Test I
1. f 2. g 3. c 4. d 5. h 6. a 7. e 8. b
Test II
1. c 4. b 7. d 10. b 13. b 16. a 19. a 22. c 25. d 28. a
2. b 5. c 8. a 11. c 14. a 17. b 20. d 23. b 26. d 29. a
3. c 6. b 9. a 12. a 15. a 18. c 21. c 24. c 27. d 30. a
Test III.
1. F 2. T 3. F 4. T 5. F 6. T 7. T 8. F 9. F 10. T
99
Lesson 4
Exercise 4.1 A.
Capital Labor Output MP AP
50 0 0 - -
50 1 20 20 20
50 2 50 30 25
50 3 75 25 25
50 4 95 20 23.75
50 5 110 15 22
50 6 120 10 20
50 7 125 5 17.85
50 8 125 0 15.62
50 9 120 -5 13.33
50 10 115 -5 11.5
B.
120
110
100
90
T
P 80
70
M 60
P
50
A 40
P 30
20
10
0
-10 0 1 2 3 4 5 6 7 8 9 10
LABOR (VI)
C. Both MP and AP eventually decline as more and more labor units are added.
D. When Q = 25; L =3
100
Exercise 4.2
A.
A. FC VC TC
200 0 200
200 50 250
200 100 300
200 200 400
200 250 450
200 300 500
B.
AFC AVC ATC MC
6.67 1.67 8.34 1.67
3.64 1.82 5.46 2.00
2.67 2.00 4.67 2.50
2.22 2.22 4.44 3.33
2.00 2.50 4.50 5.00
1.90 2.86 4.76 10.00
Lesson 4
Test I
1. True 5. False 9. True 13. False 17. False 21. False
2. True 6. False 10. False 14. True 18. True 22. False
3. True 7. True 11. True 15. True 19. False 23. False
4. True 8. False 12. False 16. False 20. True 24. True
Test II
1. d 3. 1 5. k 7. a 9. b 11. k
2. i 4. h 6. f 8. j 10. c 12. e
Test III
1. c 4. d 7. c 10. d 13. d 16. a 19. c 22. d
2. a 5. d 8. b 11. b 14. c 17. b 20. d 23. c
3. a 6. d 9. a 12. b 15. a 18. b 21. c
101
Module Test II
Name: DLC: Score:
Multiple Choice.
_____ 1. The law of demand states that
a. as price increases, quantity demanded increases.
b. as price decreases, demand increases.
c. there is a direct (positive) relationship between the price and quantity
supplied.
d. there is an inverse relationship between price and quantity supplied.
_____ 2. Consider the market for corn. If the price of fertilizer decreases, then we
can expect
a. the supply of corn to increase.
b. the supply of corn to decrease.
c. the demand for corn to decrease.
d. the demand for corn to increase.
e. the price of corn to increase.
_____ 3. If price is below equilibrium
a. quantity supplied exceeds quantity will occur.
b. quantity demanded will occur.
c. the income and substitution effects will cause rise.
d. demand will increase.
e. demand is too low for equilibrium.
_____ 4. The income effect measures the effect a price change has on
a. the relative price of other substitutable products.
b. the change in demand.
c. the purchasing power of consumer incomes.
d. national income.
e. the inflation rate.
_____ 5. If an increase in the price of product X causes a decrease in the demand
for product Y, we can conclude that
a. they are complements.
b. they are substitutes.
c. they are normal products.
d. the price of product Y will increase.
102
e. the quantity supplied of product. Y will increase.
_____ 6. If producers require higher prices to produce various quantities then
a. demand will decrease.
b. consumer incomes will decrease.
c. supply has shifted to the left.
d. quantity supplied has increased.
e. supply has increased.
_____ 7. A price floor
a. is a legal price set by the government that is below the equilibrium
level.
b. causes a shortage.
c. causes quantity demand to exceed quantity supplied.
d. is a minimum level price for which a product can be sold.
e. occurs when the market is in equilibrium.
_____ 8. Which of the following may cause a change in demand for a product?
a. change in the price of the product.
b. a change in consumer incomes.
c. a decrease in the cost of producing the product.
d. a change in the profitability of producing another product.
e. all of the above.
_____ 9. Assume the demand for watermelons is downward sloping. An increase in
price from P20 per kilo to P30 per kilo
a. will cause demand to decrease.
b. will cause a smaller quantity of watermelons to be demanded.
c. will cause a larger quantity of watermelons to be demanded.
d. could have been caused by a decrease in quantity supplied.
e. could have been caused by an increase in supply.
_____ 10. When an economist says the demand for a product has increased, he or
she means that
a. the demand curve has shifted to the left.
b. the price has decreased and consumers will therefore purchase more
of the product.
c. the product has become more scarce and consumers therefore want it
more.
d. consumers are willing and able to purchase more at any given price.
e. consumers would be willing and able to pay less to receive the same
quantity.
103
_____ 11. If population doubles in size, what can be expected to happen to the
market for automobiles?
a. people will use fewer automobiles.
b. people will buy more automobiles at any given price.
c. automobile manufacturers will decrease supply.
d. the price of automobiles will decrease.
e. none of the above will happen.
_____ 12. Consider the market for commercial movies seen on television. If there is
a decrease in the number of popular television programs, we can expect
a. demand for commercial movies to increase.
b. demand for commercial movies to decrease.
c. fewer commercial movies to be shown on television.
d. the profits of commercial movie makers to decrease.
e. none of the above.
_____ 13. If demand decreases but supply increases, we can say that
a. equilibrium price will rise, but equilibrium quantity is indeterminate,
b. equilibrium quantity will rise, but equilibrium price is indeterminate.
c. equilibrium price will decrease, but equilibrium price is indeterminate.
d. equilibrium quantity will decrease, but equilibrium price is
indeterminate.
e. we would require more information to determine the movement in price
and quantity.
_____ 14. The market demand curve is determined by
a. subtracting the demand for the product from the supply of the product.
b. adding the demand for the product and the supply o the product.
c. adding the quantity supplied by all producers at various prices.
d. adding individual demand curves.
e. subtracting supply from demand at each price.
_____ 15. If a product is in surplus supply, we can conclude that
a. its price is too low for equilibrium.
b. quantity demanded exceeds quantity supplied.
c. its price is above equilibrium.
d. consumers want to buy more than is being made available by
producers.
e. its price will rise.
_____ 16. If a natural disaster destroys Mindanao's fruit crop, then
a. the price of fruit will drop because people will consume less.
104
b. the demand for fruit will increase.
c. the supply of fruit will remain unchanged but the demand will decrease.
d. the supply of fruit will decrease, causing the equilibrium price to
increase and the equilibrium quantity to decrease.
e. the supply of fruit will decrease, causing the equilibrium price to
decrease and the equilibrium quantity to increase.
_____ 17. One reason why the quantity demanded of a good increases as its price
decreases is that
a. the lower price increase the purchasing power of consumers, enabling
them to buy more.
b. the lower price shifts demand to the right.
c. the lower price shifts demand to the left.
d. the supply of substitute products increases.
e. the number of consumers in the market increases.
_____ 18. If it is now more profitable for farmers to produce rice than corn, we can
expect
a. the supply of corn to increase.
b. the supply of corn to decrease.
c. the price of wheat to rise.
d. the quantity demanded of wheat to decrease.
e. the demand. for wheat to increase.
_____ 19. The law of supply illustrates that
a. whatever happens to price happens to quantify supplied.
b. a change in price causes a change in supply.
c. demands must decrease to cause an increase in quantity supplied.
d. as price increases, quantity supplied decreases.
e. price changes are always in the same direction as supply changes.
_____ 20. A change in supply may be caused by
a. an improvement in technology
b. changes in the profitability
c. a change in the price of inputs.
d. a change in the number of producers.
e. all of the above.
_____ 21. To say there is an elastic demand for some product means that
a. consumers are very responsive to a change in the price of the product.
b. consumers are not very responsive to a change in the price of the
product.
c. if the prices rises by some percentage, then the quantity demanded will
105
fall by a smaller percentage.
d. there is a direct relationship between price and total revenue
e. there are relatively substitutes, few competitors, and a short time
period under consideration.
_____ 22. If a product has an inelastic demand, then
a. demand shifts to the right for an inferior product..
b. the quantity demanded at any price will decrease.
c. the demand for substitute products will decrease.
d. consumers will move toward a new equilibrium in the quantities of
products purchased.
e. the marginal utility of normal products will increase.
_____ 23. If the price of home computers rises and people still buy more of them,
then
a. the law of demand does not hold.
b. this could have been caused by a change in the none price
determinants of demand.
c. demand has decreased.
d. the demand for home computers is elastic.
e. the demand for home computers is inelastic.
_____ 24. If the price of a product increases by 10 percent and the quantity
demanded decreases by 15 percent, then
a. the product has an elastic demand.
b. the product has an inelastic demand.
c. the product has a unitary elastic demand.
d. the product should raise the price further to increase total revenue.
e. total consumption expenditures have risen.
_____ 25. If a liquor store decides to raise the price of its beer in order to finance the
construction of a new building, then the owner is assuming that the
a. demand for his beer is elastic.
b. demand for his beer is unitary elastic.
c. percentage increase in the price of beer will cause a smaller
percentage decrease in the quantity demanded.
d. percentage increase in the price of beer will cause a greater
e. percentage increase in the price of beer will cause an equal
_____ 26. If consumer preferences increase for blue jeans, then
a. demand will, increase.
106
b. people will be willing to buy more at any given price.
c. people will be willing to pay a higher price to get any quantity.
_____ 27. If price elasticity of demand for a product is .5, this means
a. a change in price changes demand by 50 percent.
b. a 1 percent increase in quantity sold is associated with a .5 percent fall
in price.
c. a 1 percent increase in quantity sold is associated with a 2 percent fall
in price.
d. a .5 percent change in price will cause a .5 percent change in quantity
sold,
_____ 28. If, when income rise by 5 percent, the quantity of a commodity sold rises
by 10 percent, income elasticity is
a. -2
b. 2
c. c.-1/2
d. 1/2
_____ 29. Price elasticity of demand for a commodity tends to be greater
a. the more of a necessity it is.
b. the closer substitutes there are for it.
c. the less important it is in the budget.
d. the lower the price.
_____ 30. The profit of any unit produced can be determined by
a. adding the marginal revenue of all additional units produced.
b. adding the marginal cost of all additional units produced and
subtracting from the marginal revenue of the last unit.
c. subtracting marginal revenue from marginal cost.
d. subtracting marginal cost from marginal revenue.
e. subtracting marginal revenue from price.
_____ 31. If a firm wishes to maximize its profits or minimize its losses, then it should
a. always increase its prices.
b. always reduce its prices as low as possible.
c. produce where marginal revenue equals marginal cost.
d. produce where marginal revenue exceeds marginal cost.
e. produce where marginal cost exceeds marginal revenue.
_____ 32. Explicit cost is
a. an implicit cost plus an opportunity cost.
107
b. equal to implicit cost plus sunk costs.
c. equal to implicit cost minus sunk costs.
d. the money cost required to obtain something.
_____ 33. If marginal costs are increasing, then the marginal cost curve will be
a. horizontal.
b. vertical.
c. upward-sloping.
d. downward-sloping.
e. a circle
_____ 34. The upward-sloping portion of a firm's marginal cost curve is the firm's
a. total profit curve.
b. total cost curve.
c. supply curve.
d. marginal revenue curve
e. marginal benefit curve.
_____ 35. If a firm is producing 17 units and the marginal cost of an 18th unit is P10,
and the price it can receive for each unit sold is P11, then
a. the total revenue of 17 units is P170.
b. the firm should produce the 18th unit because marginal cost exceeds
marginal revenue.
c. the firm should produce the 18th unit because marginal revenue
exceeds marginal cost.
d. the profit of the 18th unit produced would be P11.
e. the total revenue of 18 units produced would be P180.
_____ 36. A firm
a. buys resources and sells products
b. sells. products and resources.
c. buys resources and products.
d. buys products and sells resources.
e. does none of the above.
_____ 37. A fixed cost
a. increases with increases in the output level.
b. decreases with decreases in the output level.
c. decreases with increases in the output level.
d. increases with decreases in the output level.
e. is any cost that does not vary with output level.
108
_____ 38. Any cost that varies with the output level is
a. a fixed cost.
b. a variable cost.
c. a sunk cost.
d. a negative marginal cost.
_____ 39. Total cost when output is zero, is equal to
a. sunk cost.
b. variable cost.
c. marginal cost.
d. fixed cost.
e. zero.
_____ 40. The cost structure of a firm includes
a. total fixed cost, total variable cost, and total cost
b. marginal cost, average fixed cost, average variable cost, and average
total cost.
c. risk cost and opportunity cost.
d. rises after the law of diminishing returns set in.
e. is all of the above.
_____ 41. The average variable cost curve
a. slopes downward at all output levels.
b. is a horizontal line.
c. at any output level is equal to the vertical distance between the
average total cost and average fixed cost curves.
d. intersects the average total cost curve at a high output level.
e. intersects the average total cost curve at its minimum.
_____ 42. The long-run average cost curve can be derived by
a. adding all firms' short-run average total cost curves.
b. adding all firms' short-run average variable cost curves.
c. drawing a curve that envelopes all of the firms' short-run average total
cost curves.
d. adding all of the firms short-run marginal cost curves.
_____ 43. The long-run marginal cost curve
a. intersects the long-run average cost curve downward-sloping.
b. intersects the long-run average cost curve upward-sloping.
c. intersects the long-run average cost curve at a minimum.
109
d. at first is upward-sloping and then is downward-sloping.
e. is none of the above.
_____ 44. If variable costs increases in the short-run, then
a. a firm will produce more.
b. a firm will produce less.
c. all cost curves shift up.
d. average total cost decreases.
e. average fixed cost increases.
_____ 45. The production function relates
a. cost to input
b. cost to output
c. wages to profit
d. inputs to outputs
_____ 46. Short-run average costs eventually rise because of
a. rising overhead costs.
b. rising factor prices.
c. falling marginal and average productivity.
d. reduced incentives to work in large plants.
_____ 47. The hypothesis of diminishing returns
a. predicts that sooner or later the marginal product decline in the short
run.
b. refers to reductions in total product that result as additional variable
factors are employed.
c. makes intuitive sense but has not often been confirmed empirically.
d. applies only when all inputs are used in fixed proportions.
_____ 48. If the demand equation for candies is Qd=24-2P and supply equation is
Qs=3+P, what would be the market equilibrium for the market of candies?
a. Equilibrium P=7 and Equilibrium Q = 10
b. Equilibrium P=10 and Equilibrium Q = 7
c. Equilibrium P = 9 and Equilibrium Q = 20
d. Equilibrium P = 20 and Equilibrium Q = 9
_____ 49. When the percentage change in quantity demanded is 20% and the
percentage change in price is 5%, the market demand elasticity of price is
described to be:
a. Inelastic
b. Unit Elastic
c. Elastic
110
d. Perfectly Elastic
_____ 50. In perfect market where demand and supply curves independent, an
increase in the number of buyers without change supply, the new market
equilibrium price and quantity will
a. Decrease
b. No change
c. Increase
d. None of the Choices
111

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EBC 101 / ECO 1: Introductory Economics

Module II: THE MARKET MECHANISM

SCOPE OF THE MODULE

OVERVIEW OF THE MODULE

LEARNING OUTCOMES OF THE MODULE

The concept of demand is utilized to represent the intention of a buyer in a market.

ECONOMIC BEHAVIOR OF HOUSEHOLDS

Before any further discussion, please do the following exercises.

Exercise 1.1: THE DEMAND SCHEDULE

Price (P) in pesos 5 10 15 20 25

Figure 1.1: Demand Curve for Mangoes

Exercise 1.2: THE SLOPE OF THE FIRM'S DEMAND CURVE

Price (P) in pesos 1 2 3 4 5

THE LAW OF DEMAND

OTHER FACTORS AFFECTING DEMAND

THE MARKET DEMAND FOR A COMMODITY

Figure 1.4c: Market Demand for Bananas

Exercise 1.4: MARKET DEMAND CURVE

2. Derive the market demand curve graphically.

Test I. Multiple Choice

Test II. THEORY OF DEMAND: Slope Determination

ECONOMIC BEHAVIOR OF SUPPLIER

Figure 2.1: Supply Curve for Mangoes

Market price P25

Market price P30

OTHER FACTORS AFFECTING SUPPLY

Figure 2.1: Supply Curve for Mangoes

P Figure 2.3a: Change in P Figure 2.3b: Change in

(Figure 2.3a and 2.3b).

THE MARKET SUPPLY FOR A COMMODITY

Figure 2.4c: Market Supply for Bananas

Test I. Matching Type

_____ 1. ceteris paribus a. excess supply

_____ 2. amount actually bought and sold b. quantity supplied

_____ 3. excess demand c. quantity exchanged

_____ 4. results of “Law” supply d. ratio of two absolute prices

_____ 5. relative price e. results of “law” of supply and

In Lessons 1 and 2, we considered demand and supply separately. The question

A market, therefore, consists of customers (buyers) and vendors (sellers) interacting

Figure 3.1: Market for Mangoes

Exercise 3.1: Determination of the Market Equilibrium Price and Quantity

Figure 3.5 c and d

Exercise 3.2: Elasticity Determination

Test I. Matching Type

Test II. Multiply Choice

Test III. True or False

Test IV. Market Adjustments.

B. Market for Palay

Capital Labor Output MP AP

An increasing return to scale or economies of scale happens when the proportionate

If the ATC is increasing, MC is greater than ATC.

Output AFC AVC ATC MC

Test I. True or False

Test II. Matching Type

2. 6,018.90 = 98.70 + n(90) = 65.78

Name: DLC: Score:

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