Demand, Supply and Market Forms: Laws, Elasticity and Facts

The correct answer is D. Perfect competition assumes a homogeneous product, very many buyers and sellers, perfect knowledge and free entry and exit, and the visible result of all this is a single ruling price: the same good cannot sell at two prices at the same moment, because any buyer would move to the cheaper seller at once. Option A is wrong because product differentiation is the mark of monopolistic competition, where each firm sells a branded version of the good. Option B is wrong because a multiplicity of prices for identical products is the opposite of the single price rule and happens only where knowledge is imperfect. Option C is wrong because perfect competition needs many buyers as well as many sellers; if the buyers were few, they would influence the price and the firm would no longer be a price taker.

The correct answer is A, the cigarette industry. An oligopoly is a market in which a few large firms supply the whole output, so each must watch how the others will react to its price, and the cigarette industry is the standard example because a handful of companies hold almost the entire market. Option B is wrong because barber shops are very numerous and each offers a slightly differentiated service in its own locality, which makes the trade an example of monopolistic competition. Option C is wrong for the same reason, as welding shops are many, small and locally competing. Option D is wrong because wheat growing farmers are countless and sell an identical product at a price none of them can influence, which is the closest real approach to perfect competition. Fix the examples as oligopoly for cigarettes, cement and airlines, and perfect competition for farm produce.

The correct answer is D, monopolistic competition. This form, analysed by Edward Chamberlin, keeps two features of perfect competition, a large number of firms and free entry and exit, but drops the third: each firm sells a differentiated or branded product, so it faces a downward sloping demand curve and has a little control over its own price, and selling costs such as advertising become important. Soap, toothpaste and restaurants are the usual examples. Option A is wrong because a monopsony is a market with a single buyer, not many firms. Option B is wrong because an oligopoly has only a few sellers, and entry is usually difficult. Option C is wrong because a monopoly has exactly one seller with no close substitute, which contradicts both the large number and the free entry given in the question.

The correct answer is B, inferior goods. Robert Giffen observed that when the price of a cheap staple such as coarse bread fell, poor families did not buy more of it but less, because the saving let them shift to a better food; such inferior goods are therefore called Giffen goods and their demand curve slopes upward. Option A is wrong because prestige or conspicuous goods are a separate exception, explained by the Veblen effect, in which a high price is itself the attraction. Option C is wrong because complementary goods such as a car and petrol concern cross elasticity, which is negative for them, and not the law of demand. Option D is wrong because substitute goods also belong to cross elasticity, where the value is positive, and they obey the law of demand normally. Keep the two named effects separate: Giffen for inferior goods and Veblen for prestige goods.

The correct answer is B. The law of demand records an inverse relationship: at a higher price buyers take less of a good and at a lower price they take more, which is why the demand curve slopes downward from left to right. Three reasons support it, the income effect that leaves more purchasing power when a price falls, the substitution effect that draws buyers away from costlier alternatives, and the law of diminishing marginal utility that makes each additional unit worth less. Option A states a direct relationship, which describes the law of supply instead. Option C is wrong because an unchanging quantity is only the special case of perfectly inelastic demand, not the general law. Option D is wrong because income shifts the whole demand curve but the law of demand speaks of price with income held constant.

The correct answer is B. When only the price of the good itself changes, the buyer simply moves to another point on the same demand curve, and a move to a larger quantity at a lower price is called an extension of demand, while the reverse is a contraction. Options A and C are wrong because an increase or a decrease in demand, which shifts the entire curve, is caused by a change in something other than the price of the good, such as income, tastes, the price of a substitute or complement, or the number of buyers. Option D is wrong because quantity demanded does change with price for all normal goods; only perfectly inelastic demand leaves it untouched. This distinction between a movement along the curve and a shift of the curve is among the most frequently tested points of the chapter.

The correct answer is C. Elasticity is the percentage change in quantity divided by the percentage change in price; if the numerator is zero the whole value is zero, and the demand curve becomes a vertical straight line. Life saving medicine for a patient comes closest to this case. Option A is wrong because perfectly elastic demand is the opposite extreme, where the slightest rise in price drives the quantity to nothing, the value is infinity and the curve is horizontal. Option B is wrong because unitary elasticity means the quantity changes in exactly the same proportion as the price, so total expenditure stays the same. Option D is wrong because a value greater than one describes an elastic demand, in which the quantity responds more than proportionately, as with luxuries. Remember the two extremes as zero for vertical and infinity for horizontal.

The correct answer is B. A higher price covers the rising cost of producing extra units and promises a larger profit, so sellers offer more, and the supply curve therefore rises from left to right. Option A is wrong because an inverse relationship belongs to demand, not supply. Option C is wrong because a vertical supply curve means supply cannot change at all, which is true only of a fixed stock in the very short run, such as the seats in a stadium, and not of the general law. Option D is wrong because perfectly elastic supply is a special case in which any quantity is offered at one price, drawn as a horizontal line. Note also what shifts supply rather than moving along it: the cost of inputs, technology, taxes and subsidies, the prices of other goods the firm could make, and the number of sellers.

The correct answer is B. The market clears where the demand and supply curves cut each other, that is where the quantity buyers wish to buy is exactly the quantity sellers wish to sell; the price there is the equilibrium price and the quantity the equilibrium quantity. Above that price the unsold surplus forces sellers to cut the price, and below it the shortage lets them raise it, so the market returns to equilibrium on its own through the price mechanism Adam Smith called the invisible hand. Option A is wrong because the highest profit of one seller has nothing to do with the clearing of the market. Option C is wrong because a government ceiling is an administered price imposed from outside and usually creates a shortage, as price control often does. Option D is wrong because elasticity describes the shape of a curve, not the point of intersection.

The correct answer is A. A monopoly is a market with one seller whose product has no close substitute, so the firm is the industry and is a price maker: it chooses the price and lets the market decide the quantity, or the reverse. The position survives only because entry is blocked by a patent, a licence, the ownership of a key raw material or a grant from the state. Option B is wrong because a large number of sellers of a homogeneous product is the definition of perfect competition. Option C is wrong because a single buyer facing many sellers is a monopsony, the mirror image of a monopoly. Option D is wrong because free entry and exit would destroy a monopoly at once, since new firms would come in to share the profit; it is a feature of perfect competition and of monopolistic competition instead.

The correct answer is A, duopoly. A duopoly is the limiting case of oligopoly in which only two firms supply the whole market, so each one frames its price and output with a direct eye on the other. Option B is wrong because a monopsony is a market with a single buyer, and the mistake of reading the prefix mono as two is exactly what the question is testing. Option C is wrong because an oligopsony is a market with a few buyers, again on the buying side. Option D is wrong because monopolistic competition has a large number of sellers with differentiated products. Learn the word endings: the ending poly counts sellers, as in monopoly, duopoly and oligopoly, and the ending psony counts buyers, as in monopsony and oligopsony.

The correct answer is B, Alfred Marshall. In his Principles of Economics he defined consumer surplus as the difference between what a buyer is willing to pay for a good and what he actually pays, and he also gave the standard measure of elasticity of demand, which is why his name attaches to both ideas. Option A is wrong because Adam Smith, in The Wealth of Nations of 1776, is remembered for the division of labour, the invisible hand and the foundations of classical economics. Option C is wrong because David Ricardo is associated with comparative advantage, the theory of rent and the law of diminishing returns. Option D is wrong because J. M. Keynes wrote the General Theory of 1936 and belongs to macroeconomics, with effective demand, the multiplier and the case for public spending in a depression.