Demand & Supply — Set 4

Correct Answer: B. Giffen Good

• **Giffen Good** = Giffen goods are rare, inferior goods with no close substitutes where the income effect outweighs the substitution effect, causing demand to rise with price. • **Demand rises when price rises** — Robert Giffen observed this with potatoes during the 1845 Irish Famine; as potato prices rose, poor people bought more potatoes. • 💡 Wrong-option analysis: Substitute Good: substitute goods are defined by positive cross-price elasticity, not by their reaction to own-price changes; Inelastic Good: inelastic goods show little quantity change when price changes; this is different from the paradoxical increase in demand seen in Giffen goods; Normal Good: normal goods follow the Law of Demand strictly; demand falls when price rises.

Correct Answer: B. Direct relationship

• **Direct relationship** = Substitute goods have a direct (positive) relationship: if the price of Pepsi rises, consumers switch to Coke, increasing Coke's demand. • **Positive cross-price elasticity** — The cross elasticity of demand for substitutes is always positive. • 💡 Wrong-option analysis: No relationship: there is a clear and measurable relationship between the prices of substitutes and the demand for each other; Inverse relationship: an inverse (negative) cross-price relationship describes complementary goods, not substitutes; Constant relationship: demand for substitutes does not remain constant when the rival's price changes.

Correct Answer: A. Unitary (1)

• **Unitary (1)** = On a straight-line (linear) demand curve, elasticity varies continuously; it equals exactly 1 at the midpoint of the curve. • **Ed = 1 at midpoint of linear demand curve** — Above the midpoint, demand is elastic (Ed > 1); below the midpoint, it is inelastic (Ed < 1). • 💡 Wrong-option analysis: Infinite: elasticity is infinite only at the top intercept on the Y-axis where quantity is zero and any price reduction attracts unlimited quantity; Greater than one: elasticity is greater than one only in the upper half of the linear demand curve, not at the midpoint; Zero: elasticity equals zero only at the X-axis intercept where quantity is maximised and price is zero.

Correct Answer: D. Increases

• **Increases** = As the market price of luxury cars rises, manufacturers find it more profitable to produce them, so supply increases, following the Law of Supply. • **Higher price incentivises more production** — Automakers expand shifts or open new production lines to capture higher margins at the elevated price. • 💡 Wrong-option analysis: Decreases: a price decrease would cause supply to decrease; a price increase stimulates more production; Remains constant: supply does not stay the same when price rises; higher prices create profit incentives to produce more; Becomes zero: supply can only become zero if price falls to zero or below cost; a price increase cannot eliminate supply.

Correct Answer: B. Price decreases

• **Price decreases** = Better technology shifts the supply curve to the right by lowering production costs, increasing supply and pushing the equilibrium price downward. • **Technology lowers cost, increases supply, reduces price** — The price of electronics (TVs, computers) fell for decades as manufacturing technology improved. • 💡 Wrong-option analysis: Price becomes unpredictable: technology improvements have a predictable effect — they lower costs and increase supply; Price increases: a technology improvement reduces cost and increases supply; the equilibrium price falls, not rises; Price remains same: increased supply due to lower costs shifts the supply curve right, causing price to fall.

Correct Answer: A. Fall in the price of the good

• **Fall in the price of the good** = Expansion of demand (increase in quantity demanded) occurs when the good's own price falls, causing movement along the curve. • **Expansion = movement along demand curve due to own price fall** — This is distinct from a shift; the demand curve itself does not move. • 💡 Wrong-option analysis: Rise in the price of substitute: a rise in substitute price shifts the demand curve rightward (increase in demand), not movement along the curve; Favourable change in taste: a change in taste shifts the demand curve; it does not cause expansion (movement along existing curve); Rise in the income of consumer: income rise shifts the demand curve for normal goods; it is not the cause of expansion.

Correct Answer: A. Decrease in the price of the good itself

• **Decrease in the price of the good itself** = Contraction of supply occurs when producers reduce the quantity supplied because the good's market price has fallen. • **Contraction = downward movement along the supply curve** — Only the good's own price change causes a movement along the curve; other factors cause shifts. • 💡 Wrong-option analysis: Tax increase: a tax increase shifts the supply curve leftward (decrease in supply); it does not cause a movement along the curve; Decrease in input prices: lower input prices shift the supply curve rightward (increase in supply), not a contraction along the curve; Decrease in number of firms: fewer firms shift the supply curve leftward (decrease in supply), not a movement along the existing curve.

Correct Answer: B. Its demand rises when price rises

• **Its demand rises when price rises** = The most distinctive characteristic of a Giffen good is an upward-sloping demand curve — demand increases as price rises. • **Robert Giffen's observation in 19th century Ireland** — As potato prices rose, poor Irish families could not afford meat and bought more potatoes instead. • 💡 Wrong-option analysis: Its demand falls when price rises: this describes a normal good following the Law of Demand; Giffen goods do the opposite; It is always a luxury good: Giffen goods are actually the most basic inferior goods with no substitutes; they are the opposite of luxury goods; It has no substitutes: while having no close substitutes is one condition for a Giffen good, the defining characteristic is the positive price-demand relationship.

Correct Answer: C. Inelastic

• **Inelastic** = Salt is a basic necessity with a very low household budget share and no close substitutes, making its demand highly inelastic. • **Ed much less than 1 for salt** — Even a significant price increase will not meaningfully reduce daily salt consumption. • 💡 Wrong-option analysis: Perfectly elastic: perfectly elastic demand (Ed = infinity) means any price rise drops demand to zero; salt buyers continue purchasing despite price rises; Unitary elastic: unitary elasticity means TR is constant; for salt, TR rises with price because quantity falls proportionally less; Elastic: elastic demand (Ed > 1) means quantity falls more than price rises; salt lacks close substitutes, preventing this large response.

Correct Answer: B. Shifts to the left

• **Shifts to the left** = When the price of a complement (like ink) rises, using the main good (like a pen) becomes more expensive overall, reducing demand. • **Complementary demand falls when complement price rises** — If petrol prices double, demand for cars falls because operating a car becomes more expensive. • 💡 Wrong-option analysis: Shifts to the right: a rightward shift means demand increased; rising complement prices decrease demand; Does not change: complement price changes directly affect the demand for the related good; Becomes horizontal: the slope of the demand curve reflects elasticity, not the direction of a demand shift.