Gsb728 lecture note topic 1b

transcript

Economics for Management

GSB728

Topic 2:

Markets and Prices

Note: This lecture note was prepared based on the teaching material provided

by the publisher of the textbook Principles of Economics.

Learning Objectives1. Economic systems – How do countries differ in the

way their economies are organised?

2. Demand and Supply – How much will people buy and offer of any item?

3. The free market economy – How well does it serves us?

4. The determination of price – How much of any item will actually be bought and sold, and at what price?

5. Price elasticity of demand – How responsive is demand to a change in price?

Learning Objectives (contd.)

6. Price elasticity of demand & total consumer expenditure – How much do we spend on a good at a given price?

7. Price elasticity of supply – How responsive is supply to a change in price?

8. Other elasticities – How does demand respond to changes in income and to changes in the price of other goods?

9. Markets and adjustment over time – How do markets respond in the longer term to a change in demand or supply?

10. Government fixes prices – Markets where prices are controlled – What happens if the government fixes prices?

• How do countries differ in the way their economies are organised?

• Types of economy:

– Classification by degree of government control:

• Command economies.

• Free-market economies.

• Mixed economies.

Economic Systems

Totallyplannedeconomy

Totallyfree-marketeconomy

N. KoreaCuba Poland France UK

China HongKong

Australia

Economic Systems (contd.)

Source: Sloman et al. (2014).

AustraliaTotallyplannedeconomy

Totallyfree-marketeconomy

N. Korea

Poland

Poland France

France UK

UK USA

China HongKong

CubaChina(HongKong)

Australia

Economic Systems (contd.)

The Free Market Economy

– Free decision making by individuals:• Firms seek to maximise profits.

• Consumers seek value for money from purchases.

• Workers seek to maximise wages.

– The price mechanism:• Shortages and surpluses.

– Shortage price rises.– Surplus price falls.

• Equilibrium price:– Where demand equals supply.

• Equilibrium:– A position of balance.

– Effects of changes in demand and supply:• A change in demand.• A change in supply.

– Interdependence of markets:• Effects of a rise in demand.

– In the goods market.

The Free Market Economy (contd.)

Goods Market:

Dg Shortage(Dg > Sg)

Dg ¯until Dg = Sg

The Price Mechanism: Effect of a Rise in Demand

– Effects of changes in demand and supply:• A change in demand.• A change in supply.

– Interdependence of markets:• Effects of a rise in demand.

– In the goods market.– In the factor market.

Goods Market:

Dg Shortage(Dg > Sg)

Dg¯until Dg = Sg

Factor Market:

until Df = SfDf Shortage(Df > Sf)

The Price Mechanism: Effect of a Rise in Demand (contd.)

– Competitive markets:• Perfectly competitive markets.

• Everyone is a price taker.

• Why study perfect markets?

Demand and Supply

The Demand Curve

Demand

• The relationship between demand and price:– Law of demand.– Income effect.– Substitution effect.

• The demand curve:– Assumptions (all other things (determinants) equal).– The axes.– Illustrates how much would be demanded at each

price.

($ per kg)

Tracey's Demand

Darren's Demand

Total Market Demand

(tonnes: 000s)

A 0.40 28 16 700

B 0.80 15 11 500

C 1.20 5 9 350

D 1.60 1 7 200

E 2.00 0 6 100

The Demand Curve:The Demand for Potatoes (Monthly)

0 50 100 150 200 250 300 350 400 450 500 550 600 650 700 750 8000

Quantity (tonnes: ‘000s)

Price($ per kg)

Market Demand(tonnes 000s)

Demand

Source: Sloman et al. (2014). 17

Market Demand for Potatoes (Monthly) (contd.)

0 50 100 150 200 250 300 350 400 450 500 550 600 650 700 750 8000

Quantity (tonnes: ‘000s)

Price($ per kg)

Market Demand(tonnes 000s)

Demand

B 0.80 500

C 1.20 350C

D 1.60 200

E 2.00 100

18Source: Sloman et al. (2014).

Demand and Supply

Shifts in Demand

• Other determinants of demand:– Tastes.– Number and price of substitute goods.– Number and price of complementary goods.– Income.– Distribution of income.– Expectations of future price changes.

• Movements along and shifts in the demand curve.

Demand

O Q0 Q1 Quantity

Increase in Demand

OQ1 Q0 Quantity

Decrease in Demand

Demand and Supply

The Supply Curve

Supply• Supply and price:

– As price rises, firms supply more.• It is worth incurring the extra unit costs.• They switch from less profitable goods.• In the long run, new firms will be encouraged to enter

the market.

• The supply curve:– Assumptions (all other determinants are constant).– The axes.– Illustrates how much would be supplied at each price.

The Supply Curve: The Supply for Potatoes (Monthly)

Price of Potatoes ($ per kg)

Farmer X's Supply (tonnes)

Total Market Supply

(tonnes: 000s)

a 0.40 50 100

b 0.80 70 200

c 1.20 100 350

d 1.60 120 530

e 2.00 130 700

2 Supply

Quantity (tonnes: 000s)

Market Supply for Potatoes (Monthly) (contd.)

2 Supply

b 0.80 200c

c 1.20 350

d 1.60 530

e 2.00 700

Market Supply for Potatoes (Monthly) (contd.)

Demand and Supply

Shifts in Supply

• Other determinants of supply:– Profitability of alternative products.– Profitability of goods in joint supply.– Nature, random shocks and other unpredictable

events.– Aims of producers.– Expectations of future price changes.– The number of suppliers.

• Movements along and shifts in the supply curve.

Supply

Shifts in The Supply Curve

Increase in supply

Decrease in supply

Determination of Price

• Equilibrium price and output:• Response to shortages and surpluses.

• Market clearing.

• Significance of ‘equilibrium’.

– Demand and supply curves.

Equilibrium Price and Output:Market Demand and Supply of Potatoes (Monthly)

Price of Potatoes ($ per kilo)

Total Market Demand (Tonnes: 000s)

Total Market Supply (Tonnes: 000s)

0.40 700 (A) 100 (a)

0.80 500 (B) 200 (b)

1.20 350 (C) 350 (c)

1.60 200 (D) 530 (d)

2.00 100 (E) 700 (e)

eSupply

Demand

Determination of Market EquilibriumP

– Demand and supply curves.– Effect of price being above equilibrium.

• Surplus price falls

Determination of Price (contd.)

e Supply

Demand

D dSURPLUS

(330 000)

Determination of Market Equilibrium (contd.)P

– Demand and supply curves.

– Effect of price being above equilibrium.• Surplus price falls.

– Effect of price being below equilibrium.• Shortage price rises.

e Supply

Demand

SHORTAGE(300 000)

Determination of Market Equilibrium (contd.)

Demand and Supply

Market Equilibrium

– Demand and supply curves.– Effect of price being above equilibrium.

• Surplus price falls.

– Effect of price being below equilibrium.• Shortage price rises.

– Equilibrium: where D = S.

eSupply

Demand

Determination of Market Equilibrium (contd.)

• Movement to a new equilibrium:

– Effects of shifts in the demand curve:

• Movement along S curve and new D curve.

• Rise in demand (rightward shift) P rises.

• Fall in demand (leftward shift) P falls.

Demand and Supply

Effect of a Shift in the Demand Curve

Demand and Supply

Effect of a Shift in the Supply Curve

Qe3Qe1

Effect of a Shift in the Supply Curve

Markets, Demand and Supply

Economic Systems

The Free-Market Economy

• Advantages of a free-market economy:• Transmits information between buyers and sellers.

• No need for costly bureaucracy.

• Incentives to be efficient.

• Competitive markets respond to consumer wishes.

• Problems with a free-market economy:• Competition may be limited.

• Inequality.

• Environment and social goals may be ignored.

The Mixed Economy

– Types of intervention:• Use of taxes, subsidies and benefits.

• Legislation and regulation.

• Direct provision by the government.

Elasticities

Elasticities of Supply and Demand

Price Elasticity of Demand

• Defining price elasticity of demand (PeD):– Responsiveness of quantity demanded to a change

in price.

OQ3Q1 Q2

Quantity

Market Supply and Demand

Price Elasticity of Demand

• Measuring price elasticity of demand:

%QD / %P

– Percentage measure.

– Negative sign.

– Value: greater or less than 1 (in absolute value).

Price Elasticity of Demand (contd.)

– PeD>1:Elastic demand

– PeD<1:Inelastic demand

– P e D=1:Unit elastic demand

Elasticity

Measuring Elasticity

0 10 20 30 40 500

Demand

Measuring Elasticity

Quantity

0 10 20 30 40 500

= -7/3 = -2.33

DQ DPmid Q mid P¸ Ped =

Demand

nMid P7

Mid Q15

Measuring Elasticity (contd.)

Q = 10

P = –2

Quantity

10 -2 15 7

= 10/15 x -7/2

= -70/30

• Determinants of price elasticity of demand:

– Number and closeness of substitute goods.

– Proportion of income spent on the good.

– Time period.

Price Elasticity of Demand (contd.)

Price Elasticity of Demand andTotal Consumer Expenditure

• Defining total consumer expenditure:

– TE = P × Q

• Next slide illustrates TE graphically…

0 1 2 3 4 50

Total ExpenditureP

Quantity

Consumers’ total expenditure

=firms’ total revenue

=$2 x 3m = $6m

• Effects of a price change: Elastic demand.

– P rises: TE falls.

– P falls: TE rises.

Price Elasticity of Demand andTotal Consumer Expenditure (contd.)

Effect of Advertising on Demand Curve

Elasticity

Elastic and Inelastic Demand

Elastic Demand Between Two PointsP

Quantity10

Total expenditure fallsas price rises from $4 to $5:

($4 x 20) > ($5 x 10)

• Effects of a price change: Inelastic demand.

– P rises: TE rises

– P falls: TE falls

Total expenditure rises as price

rises from $4 to $8:

($4 x 20) < ($8 x 15)c

Inelastic Demand Between Two PointsP

Quantity

Different Elasticities Along a Demand Curve

• Special cases:– PeD = 0 : Totally inelastic demand

– PeD = - : Infinitely elastic demand

– PeD = –1 : Unit elastic demand

Totally Inelastic Demand (PÎD = 0)

Quantity

Q2O Q1

P1 Da b

Infinitely Elastic Demand (PÎD = ¥)

QuantitySource: Sloman et al. (2014). 69

Unit Elastic Demand (PÎD = -1)

Quantity

Total expenditure remains unchanged as price falls

from $20 to $8:

($20 x 40) = ($8 x 100)

Elasticity

Elastic and Inelastic Supply

Price Elasticity of Supply• The elasticity of supply determine how

responsive is the quantity supplied to changes in prices.

• Measuring price elasticity of supply:

%QS / %P

– Positive sign.

– Elastic and inelastic supply, >1 and <1 respectively.

Supply Curves with Differing Price ElasticityP

Quantity73Source: Sloman et al. (2014).

• Determinants of price elasticity of supply:

– Amount that costs rise as output increases:• Spare capacity.

• Access to raw materials.

• Ability to switch away from alternative products.

• Avoidance of the need to pay overtime.

– Time period:• Immediate: Highly inelastic.

• Short run: Some responsiveness.

• Long run: Highly elastic.74

Price Elasticity of Supply (contd.)

Elasticity

Markets and Adjustment Over Time

• Short-run and long-run adjustment:

– Short-run and long-run supply curves.

– Short-run and long-run demand curves.

S long-run

Q1 Q2 Q3O

S short-run

Quantity

Response of Supply to an Increase in Demand

D short-run

D long-run

Q1 Q2 Q3O

Quantity

Response of Demand to an Increase in Supply

Speculation

Stabilising Speculation

Suppliers and/or demanders believe that a change in price is only temporary.

Stabilising Speculation: Initial Price Rise and Then Fall

Quantity

Q1 Q3 Q2

Stabilising Speculation: Initial Price Fall and Then Rise

Quantity

Q2 Q3 Q1

Speculation

Destabilising Speculation

Suppliers and/or demanders believe that a change in price heralds similar changes to come.

Destabilising Speculation: Price RiseP

Quantity

Q1 Q2,3Source: Sloman et al. (2014). 83

Destabilising Speculation: Price FallP

Quantity

Q2,3 Q1

Markets and Adjustment Over Time

• Dealing with uncertainty and risk:

– Defining risk and uncertainty.

– Reducing risks by holding stocks and diversification.

– Market information.

Elasticity

Other Elasticities

Income Elasticity of Demand

• Income elasticity of demand.– Measurement:

%QD / %Y

– Determinants:• Degree of necessity.• Level of income.

– Type of good:• Normal goods.• Inferior goods.

• Cross-price elasticity of demand.– Measurement:

%QD of good A / %P of good B

– Determinants:• Closeness of substitute goods.• Closeness of complement goods.

Cross-Price Elasticity of Demand

Effect of Imposing Tax on Goods

Price Controls

Minimum (High) Price: Price Floor

Minimum Price

Surplus

Minimum Price: Price FloorP

QuantityQe

Consequences of Price Floor

– Consequences:• Dealing with resulting surpluses.• Inefficiency.• Discourage production of more efficient alternative

products.• Higher prices for consumers.

– Examples: Common Agricultural Policy (EU).

Price Controls

Maximum (Low) Price: Price Ceiling

Maximum Price

Shortage

Maximum Price: Price CeilingP

QuantityQd

– Consequences:• Dealing with resulting shortages.

• Preferential treatment to particular customers (firms or government decide who can buy the product and volume).

• Rationing.

• Black markets.

Consequences of Price Ceiling

References

Morales, L. E., Simons, P. and Valle de Souza, S. (2014). GSB728: Economics for Management [Topic Notes]. Armidale, Australia: University of New England, Graduate School of Business.

Sloman, J., Norris, K and Garratt, D. (2014). Principles of Economics (4th ed.). French Forest, Australia: Pearson.

Gsb728 lecture note topic 1b

Technology