Post on 20-Jan-2016
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Unit 2
Allocation of Resources
Which one do you like?
Market Economy• Consumers decide what to produce.
• Private property
• Changes in supply and demand control the prices
• No Government Intervention
• Market economy is an ideal which does not exist today
Advantages……….Advantages……….• Freedom for everyone Freedom for everyone
• No Government Intervention No Government Intervention
• Variety of goods and services are produced – Variety of goods and services are produced – Consumer ChoiceConsumer Choice
• High consumer satisfactionHigh consumer satisfaction
• It is Efficient It is Efficient
• Has • Private Sector – privately
owned• Public Sector – owned by
govt.
• Govt produces some goods. Eg: Roads, Hospitals, Schools, etc
• Government intervention is very less.
Mixed Economy
• Government decides what to produceGovernment decides what to produce
• Everything owned by government – No Everything owned by government – No private ownershipprivate ownership
• Government decides the pricesGovernment decides the prices
• No consumer choice No consumer choice
Planned Economy
The amount of money a product is worth is called its “Price”
A place (any size) where a buyer buys & seller sells is called MARKET
What is Demand?• Demand is the quantity of a product that
consumers are –Willing to buy–Able to buy–At a price–Over a period of time
• Individual demand - the demand of one consumer
• Market demand is the total demand of all the consumers.
When goods are cheap, People buy more
When goods are expensive, People buy less
The Demand Curve
D
3000 5000 7000
2000
1600
800
Price ($)
Quantity
The demand curve shows the quantity demanded at any given price.
The Demand Curve
Q
P
R
The Demand Schedule
The Demand Schedule shows quantities demanded at given price (usually set by the producer)
Changes in Demand Curve
• The changes can be• Movement along Demand Curve• Shifts of Demand Curve
0 1 2 3 4 5
0
10
20
3
0
40
50
60
Price
Quantity
Movement of Demand Curve
0 1 2 3 4 5
0
10
20
3
0
40
50
60
As the price changes, the quantity demanded will also change.
Price
Quantity
0 1 2 3 4 5
0
10
20
3
0
40
50
60
Price
Quantity
Shift of Demand Curve
0 1 2 3 4 5
0
10
20
3
0
40
50
60 At the same price, a
different quantity is demanded.
Price
Quantity
• Fashion of cloth changes Demand changes
• A research shows that dark chocolate is healthy Demand ↑
• More people want to become vegetarian Demand of meat ↓
• If Advertising of a product is successful demand ↑
Taste & Fashion
• Disposable income = Income – Tax
• Income ↑ Demand↑• Income ↓ Demand ↓
IncomeIncome
• If population is more Demand is more
PopulationPopulation
Price of Related GoodsPrice of Related Goods
Substitute Goods
P ↑ D ↑
P↓ D ↑
P ↑ D ↓
P↓ D ↓D↓
Complement Goods
Weather
Expectations of future prices changes• If consumers expect prices ↑ Demand ↑ now
• If consumers expect prices ↓ Demand ↓ now.
Other Factors
The supply curve
• Supply is the quantity of a product that suppliers are –willing to sell –Able to sell –At various prices –Over a period of time
What is Supply?
• Individual Supply - the supply of one Firm/ Producer
• Market Supply is the total Supply of the Market
When goods are cheap, producer sell less
When goods are expensive, producer sell more
The Demand Curve
The Supply curve shows the quantity supplied at any given price.
The Supply Curve
40
80
120
160
200
10 20 30 40 500 60 70
S
Pric
e
0Quantity
The Supply Schedule
The Supply Schedule shows quantities supplied at given price
Changes in Supply Curve
• The changes can be• Movement along Supply Curve• Shifts of Supply Curve
Movement of Supply Curve
Pric
e
Quantity
$15A
1,250 1,500
B$30
SAs the price
changes, the quantity supplied will also change.
Shift of Supply Curve
Pric
e
Quantity
SS1
$15A B
1,250 1,500
S2
At the same price, a different quantity is supplied.
Cost of Production (COP)
COP↑ supply ↓ & COP ↓ supply ↑
COP may change due to change in……. –Wages (Salary)–Productivity (output per worker)–Raw material–Energy costs (Electricity)–Transport costs
If government puts taxes COP ↑ Supply ↓
IncomeTaxes
• If the government gives a subsidy then the Cost of production ↓ and Supply ↑
PopulationSubsidies
Price of Related GoodsPrice of Related Goods
The Profitability of Goods in Joint Supply
• DVD Players and DVD are produced together.
• When the Price of DVD Players ↓ Demand of DVD Players ↑ So more DVDs are needed So the Supply of DVDs ↑) also increase.
The Profitability of Substitutes in Supply
• If Mango Juice becomes more PROFITABLE than Apple Juice, producers will produce more Mango juice .
SoSupply of Mango juice ↑ & Supply of Apple Juice ↓
War Weather - Earthquakes , floods & fireThe breakdown of machineryExpectations of future prices changes
– If producers expect prices ↑ Supply ↓ now & will build up STOCKS
– If producers expect prices ↓ Supply ↑ now & reduce production
Other Factors
• Demand & Supply Demand & Supply of a product of a product determines the determines the PRICEPRICE of a of a product!!!product!!!
• WhenWhen
• Demand = Supply Demand = Supply EquilibriumEquilibrium
• Demand ≠ Supply Demand ≠ Supply DisequilibriumDisequilibrium
46
Demand = Supply (Equilibrium Point)
AS Economics Unit 2 Chapter 7 47
• SurplusSurplus – Supply > DemandSupply > Demand
• ShortageShortage – Demand > SupplyDemand > Supply
Why the Equilibrium Changes?
–Change in Demand–Change in Supply–Change in Demand & Supply
“The responsiveness (changes) in one variable due to the change in the other
variable – Elasticity”
PED – Price Elasticity of demandPES – Price Elasticity of Supply
• When price ↑, what happens to demand?• Demand Decreases↓
BUT!• How much does demand decrease?• Eg: • If price rises by 10%• The demand will decrease
– By more than 10%? Or – By less than 10%?
“A responsive change in demand with a change in the price is called Price Elasticity
of Demand (PED)”
• If a small change in price, produce a bigger change in demand demand is elastic.
• If a large change in price, produce a small change in demand demand is inelastic.
PED - Formula
• PED =% change in quantity demanded of a product
% change in price of that product
PED = % Q△
% P△PED is always
negative
Elastic Demand
Price (£)
Quantity Demanded
D
10
5 20
If Producer decrease the pirce from 10 to 7
7
% Δ in Price = - 30%
% Δ in Demand = + 300%
PED = - 10 (Elastic)
A small change in price, produce a bigger change in demand Demand is ELASTIC.
Inelastic Demand
Price (£)
Quantity Demanded
10
D
5
5
6
% Δ Price = -50%
% Δ Demand = +20%
PED = -0.4 (Inelastic)
If a large change in price, produce a small change in demand Demand is INELASTIC.
If Producer decrease the pirce from 10 to 5
So, the PED can be
a) Perfectly Inelastic PED = 0
b) Perfectly Elastic PED = (-) ∞
c) Unitary Elastic PED = (-) 1
Elasticity of Demand
Demand does not change with change in price
Demand changes infinitely with a change in price
Change in Demand is same as change in price (But Inverse)
The range of the Elasticity of Demand
Inelastic
Unit elastic
Elastic
This value can range from zero to infinitely (in absolute value)
0 1A 1% change in less than 1% change in quantity
A 1% change in price exactly 1% change in quantity
A 1% change in price larger than 1% change in quantity
• When price ↑, what happens to Supply?• Supply Increases
BUT!• How much does Supply Increase?• Eg: • If price rises by 10%• The supply will increase
– By more than 10%? Or – By less than 10%?
“A responsive change in supply with a change in the price is called Price
Elasticity of Supply (PED)”
• If a small change in price, produce a bigger change in supply Supply is elastic.
• If a large change in price, produce a small change in supply Supply is inelastic.
PES - Formula
• PES =% change in quantity Supplied
% change in price
PES = % Q△
% P△PES is always
Positive
PES - Formula
So, the PES can be
a) Perfectly Inelastic PES = 0
b) Perfectly Elastic PES = ∞
c) Unitary Elastic PES = 1
Elasticity of Supply
Supply does not change with change in price
Supply changes infinitely with a change in price
Change in Supply is same as change in price
The range of the Elasticity of Supply
Inelastic
Unit elastic
Elastic
This value can range from zero to infinitely (in absolute value)
0 1A 1% change in Price less than 1% change in quantity
A 1% change in price exactly 1% change in quantity
A 1% change in price larger than 1% change in quantity
Importance of PED
If the firm knows the PED of its product, – If it is elastic
• It can decide to decrease the price, to maximize sales maximum profit
– If it is inelastic• It can increase the price and earn more
profits• Or can pass the tax to the consumer
Importance of Elasticity of Supply
• If the Demand increases, a firm will know if it can meet the increased demand with/without changing prices– If Supply is Elastic Demand is met
without increasing price.– If Supply is Inelastic Demand is met only
with a sharp increase in price.