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.