The Prize Puzzle — What Drives the Market — Practice

Question 1

What is a market in economics?

Accepted Answer

Any arrangement that brings buyers and sellers together to exchange goods and services (not necessarily a physical place).

✦ Answer: an arrangement connecting buyers and sellers to exchange.

Question 2

What problem of the barter system does money solve?

Accepted Answer

The 'double coincidence of wants' — the need for each person to want exactly what the other offers.

✦ Answer: it removes the need for a double coincidence of wants.

Question 3

State the law of demand.

Accepted Answer

Other things being equal, as the price of a good rises its demand falls, and as the price falls its demand rises.

✦ Answer: demand falls when price rises and rises when price falls.

Question 4

How do demand and supply respond differently to a rise in price?

Accepted Answer

Step 1 — By the law of demand, a rise in price REDUCES the quantity demanded (buyers buy less).

Step 2 — By the law of supply, a rise in price INCREASES the quantity supplied (sellers offer more).

✦ Answer: a price rise lowers demand but raises supply.

Question 5

What is the equilibrium (market) price?

Accepted Answer

Step 1 — It is the price at which the quantity that buyers want to buy equals the quantity that sellers want to sell.

Step 2 — At this price the market is balanced — there is neither a surplus nor a shortage.

✦ Answer: the price where quantity demanded equals quantity supplied.

Question 6

What happens if the price of a good is set too high?

Accepted Answer

Step 1 — At a high price, sellers supply a lot but few buyers are willing to buy.

Step 2 — This creates a surplus (unsold goods), which pushes the price back down towards equilibrium.

✦ Answer: a surplus forms, and the price falls towards equilibrium.

Question 7

Using demand and supply, explain why tomato prices shoot up when there is a poor harvest.

Accepted Answer

Step 1 — A poor harvest reduces the SUPPLY of tomatoes reaching the market.

Step 2 — With demand roughly the same but fewer tomatoes available, buyers compete for the limited supply.

Step 3 — This pushes the price up until the higher price reduces demand enough to match the smaller supply.

✦ Answer: reduced supply against steady demand raises the price until the two balance again.

Question 8

How does price act as a signal in a market economy?

Accepted Answer

Step 1 — A high price signals producers to make MORE of a good (it is profitable) and tells buyers to use it carefully.

Step 2 — A low price signals producers to make LESS and tells buyers they can use more.

Step 3 — In this way prices coordinate the decisions of countless buyers and sellers, helping decide what, how and for whom to produce — without central command.

✦ Answer: prices signal producers how much to make and buyers how much to use, coordinating the economy.

Question 9

Why do governments sometimes interfere with market prices? Give examples.

Accepted Answer

Step 1 — Markets driven purely by demand and supply can push essential goods out of the reach of the poor, or leave farmers with unfairly low prices.

Step 2 — So governments intervene to protect people — e.g. minimum support prices for farmers' crops, subsidised food through the public distribution system (ration shops), and regulation of prices of essentials.

Step 3 — This mix of market and government action is why India is called a mixed economy.

✦ Answer: to protect the poor and producers from unfair prices — via support prices, rationing and regulation (a mixed economy).

Practice — The Prize Puzzle — What Drives the Market

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