ib economics sl 2 - supply and demand

7/30/2019 IB Economics SL 2 - Supply and Demand

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2.1 Introduction to competitive marketsMARKETS

A market includes any kind of arrangement where buyers and sellers of goods and

services are linked to perform an exchange. It can be local, national, and international.

Competition is a process in which rivals compete to get an objective.

Market (monopoly) power is the power a seller has over a products price.

2.2 DemandLAW OF DEMAND AND DEMAND CURVE

Concerned with the behavior of buyers (both consumers and producers).

The demand of a consumer indicates the quantities of a good the consumer is willingand able to buy at different prices, ceteris paribus.

A demand schedule lists the quantity demanded at different prices.

The graphic to the right is a demand curve.

The law of demand states that theres a negative causal

relationship between the price and Qd. If the price of a good falls,

Qd increase, and vice versa, ceteris paribus.

Reasoning of law of demand: each successive good consumed will

produce less benefit. Marginal benefit is the extra benefit you get

from an extra unit of a good/service.

Market demand is the sum of all individual demand for a good, and also the sum of the

marginal benefits.

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COMPETITIVE MARKETS: DEMAND AND SUPPLY

ECONOMICSSL

chapter two - competitive markets: demand and supply

Demand

Qd

P

D1

D2

Qd

P

D2

D1

Qd

P

D

A

B

Increase in demand Decrease in demand Change in Qd


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NON-PRICE DETERMINANTS OF DEMAND

Non-price determinants are variables that can influence demand (but not price). The

demand curve shifts when there are changes in these determinants.

A normal good is a good that responds to an income increase with a demand increase.

An inferior good will decrease in demand as income increases. Substitute goods satisfy similar needs, i.e. Coca-Cola and Pepsi.

Complementary goods tend to be used together.

Non-price determinants of demand include:

Income (normal goods) - An increased income will increase demand for normal

goods, and vice versa, ceteris paribus.

Income (inferior goods) - An increase in income will decrease the demand for inferior

goods, and vice versa, ceteris paribus, because consumers pursue better items.

Preferences and tastes - Demand increases if tastes change to favor the product, and

decreases if goods become less popular.

Prices (substitute goods) - A fall in the price of one good will result in a fall in the

demand for the other, because consumers change to the cheaper good.

Prices (complementary goods) - A fall in the price of one good will result in an

increase in the demand for the other.

Change in demographics - An increase in the amount of buyers will increase demand

and shift the market demand curve to the right.

MOVEMENTS ALONG A CURVE

A change in price will result in a movement along the demand curve, ceteris paribus. This

is called change in quantity demanded.

A change in one of the non-price determinants will shift the demand curve and cause a

change in demand.

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2.3 SupplyLAW OF SUPPLY AND SUPPLY CURVE

Concerned with the behavior of sellers.

The supply of a firm shows the quantities of a good the firm is

willing and able to produce and supply at certain prices, ceteris

paribus.

A demand schedule can present the different quantities and prices.

The supply curve maps the demand to a chart.

There is a positive causal relationship between the price and

quantity demanded.

The law of supply states that as a price of a good increases, the quantity supplied

increases, and vice versa, ceteris paribus.

The supply curve slopes up because firms like to produce more output to increase profit.

Market supply is the sum of all individual supplies. There can be avertical supply curve. The quantity supplied cannot increase even as

price increases.

There is a fixed quantity of a good supplied and there is no time to make more.

There is a fixed quantity of a good because there is no chance of making more of it.

NON-PRICE DETERMINANTS OF SUPPLY

Non-price determinants are factors that are not price that influence supply.

Competitive supply of products refers to the production where different goods compete

for the same resources, i.e. wheat or corn.

Joint supply of products refers to the production of goods taken from a single product,

like milk and beef.

Subsidies are payments given by the government to encourage an increase of

production.

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Supply

Qs

PS1

S2

Qs

P S2

S1

Qs

P

D

A

B

Increase in supply Decrease in supply Change in Qs


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Non-price determinants of supply include:

Costs of factor of production - If the price of a factor increases, production costs

increases, and the supply decreases, and vice versa.

Technology - Improved technology can lower costs of production and increases the

supply.

Prices (competitive supply) - If the price of good A increases, it will be producedmore, and the supply of good B will decrease.

Prices (joint supply) - An increase in price in a good will increase the quantity

supplied of that good and an increase in supply for a joint good.

Expectations - A firm can produce less if it expects that they can sell it for a higher

price in the future. Supply decreases. If they believe less will be sold later on, supply

increases for now.

Taxes - Taxes are treated as costs of production. Taxes will decrease supply.

Subsidies - An increase in subsidies is a decrease in production costs, so supply

increases.

Firm amount - Increase in number of firms producing a good will increase supply.

Shocks - Unpredictable events can affect the supply curve.

MOVEMENTS ALONG A CURVE

A change in price will cause a movement along the curve, called a change in quantity

supplied.

A change in a determinant (non-price) will cause movement of the curve, or a change in

supply.

2.4 Market equilibrium: demand and supplyMARKET EQUILIBRIUM

If Qd is less than Qs, there is excess supply and the difference is the surplus.

If Qd is greater than Qs, there is excess demand and the difference is called shortage.

In a free market, the price will change during a shortage or surplus so that Qd = Qs.

Equilibrium is the state of balance so theres no tendency to change.

Market equilibrium is the balance of supply and demand and it is where the demandcurve intersects the supply curve.

CHANGES IN MARKET EQUILIBRIUM

The market will adjust to a new equilibrium if there is a change in a non-price

determinant.

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If the demand curve increases, but the price remains the

same, there will be disequilibrium. At this new point,

there will be a shortage. As a result, the price will be

forced to go up to maintain equilibrium.

If the supply curve increases due to determinant changes

but the price remains the same, there will be a surplusbecause Qs > Qd. The price will fall until equilibrium is

reached.

2.5 Linear demand and supply (HL)UNAVAILABLE

2.6 The role of the price mechanism and market efficiencyPRICES AS SIGNALS AND INCENTIVES

The invisible handis a phrase used by Adam Smith that co-ordinates decisions of

decision-makers without a central authority.

Prices as signals communicate information to decision-makers.

Prices as incentives motivate decision-makers to respond.

Example: demand increases in product (strawberry) market

At initial price, there is a shortage, and price rises until shortage disappears.

Higher price signals producers that there is a shortage and incentivizes them to

increase quantity supplied.

The new higher price signals consumers that strawberries are more expensive andincentivizes them to buy less.

Example: supply increases in resource (labor) market

Increase of labor causes surplus and wage falls until equilibrium.

Falling wage signals firms that there is a surplus and incentivizes them to hire more.

Falling wage also signals workers that there is a lower wage and incentivizes them to

offer less services.

EFFICIENCY IN COMPETITIVE MARKETS

Allocative efficiencyis the producing of a combination of goods most wanted by society.

It is achieved when no one can become better off without someone being worse off.

Productive efficiencyis the production of goods with the fewest possible resources.

These answer the how to produce and what to produce questions.

A society needs to have productive efficiency to be allocative efficient.

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Market Equilibrium

Q

P

D

S

surplus

shortage

excess supply

excess demand

market equilibriumequilibrium price

equilibrium quantity


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SURPLUS

Consumer surplus is the highest price consumers are willing to pay for a good minus the

price actually paid. It is the shaded area between the

demand (marginal benefit) curve and the equilibrium

price.

Producer surplus is the price received for selling agood minus the lowest price the firm wants to produce it

for. (The lowest price must be enough to cover the cost

of producing one more unit). It is between the supply

(marginal cost) curve and equilibrium price.

Social surplus (community surplus) is the sum of CS and

PS.

For allocative and productive efficiency to be achieved,

MB = MC must hold in all markets.

Welfare - the well being of society. Social welfare is

maximized when MB = MC.

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Surplus

Q

P

D=

S= M

consumer surplus

producer surplusMB = MC

ib economics sl 2 - supply and demand

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