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LEARNING OUTCOME 2 & 3

LEARNING OUTCOME 2 & 3. DEMAND AND SUPPLY. DEMAND. EFFECTIVE DEMAND desire to purchase backed by the ability to pay DETERMINANTS OF DEMAND: Price Tastes Income Fashion Advertising Availability and price of substitutes Price of compliments Time of year Consumers’ expectations

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LEARNING OUTCOME 2 & 3

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  1. LEARNING OUTCOME 2 & 3 DEMAND AND SUPPLY

  2. DEMAND EFFECTIVE DEMAND • desire to purchase backed by the ability to pay DETERMINANTS OF DEMAND: • Price • Tastes • Income • Fashion • Advertising • Availability and price of substitutes • Price of compliments • Time of year • Consumers’ expectations • Availability of credit • Population • Utility yielded

  3. UTILITY UTILITY • the satisfaction which we obtain from goods and services MARGINAL UTILITY • the satisfaction obtained from the last unit • will diminish with each successive unit consumed - the law of diminishing marginal utility TOTAL UTILITY • the satisfaction obtained from all units consumed CONSUMER OPTIMUM • maximising total utility - the theory of equi-marginal returns: MU A = MU B = MU C = MU n Price A Price B Price C Price n

  4. THE LAW OF DEMAND More will be demanded at lower prices and less at higher price. • Reasons for slope of Demand Curve: • Law of Diminishing Marginal Utility • Substitution Effect • Income Effect When price rises from P to P1 quantity demanded contracts from Q to Q1. When price falls from P to P2 quantity demanded extends from Q to Q2

  5. QUIZ What is meant by effective demand? Wants backed up by money Price, tastes, availability of substitutes and the price of compliments Name any 4 determinants of demand How do we refer to the satisfaction yielded by the last unit consumed? Marginal Utility What happens to satisfaction as we consume more of a commodity? Marginal utility decreases with each unit consumed How can individuals maximise their total satisfaction? By equalising the marginal utility: price ratio for all goods consumed Describe the relationship between price and quantity demanded. It is an inverse relationship Law of Diminishing Marginal Utility The Substitution Effect The Income effect What explains this relationship? What happens on the demand curve when price rises? There is a contraction of demand What happens on the demand curve when price falls? There is an extension of demand

  6. PRICE ELASTICITY OF DEMAND E = % change in Quantity Demanded % change in Price > 1 is relatively price elastic < 1 is relatively price inelastic = 1 is unit price elasticity Products which are price elastic have a relatively flat demand curve so that in response to even a relatively small price change, quantity demanded changes more than in proportion to price. Measures the responsiveness of demand to price changes Products which are price inelastic have a relatively steep demand curve so that even relatively large price changes generate proportionately smaller changes in quantity demanded.

  7. PRICE ELASTICITY OF DEMAND With straight line demand curves elasticity will vary along the length of the curve. Perfectly Elastic Demand E=% Change in Quantity Demanded % Change in Price 10 x 100 10 = 100% 1 x 100 = 20% = 5 5 Relatively Elastic 10 x 100 40 = 25% 1 x 100 = 50% = 0.5 2 Relatively Inelastic Perfectly Inelastic Demand

  8. PRICE ELASTICITY OF DEMAND When using the formula for price elasticity of demand, the sign is assumed to be negative (-). This is because normal goods follow the law of demand and have a normal, downward sloping demand curve. Products whose quantity demanded increases when price increases would give a positive (+) value for price elasticity and have an exceptional demand curve. If a positive (+) value is obtained this is an exceptional good – one which does not follow the law of demand ie one which has an exceptional demand curve. An example of this could be the demand for a painting by a particular artist, which only becomes desirable as an investment by a collector, when the price starts to rise.

  9. QUIZ What is the price elasticity of demand if the price of Commodity X rises from 80p to 85p and, as a result, the demand falls from 100 per week to 75 per week? 25 x 100 100 1 = 25% = 4 ie fairly elastic 5 x 100 6.25% 80 1 If the demand for commodity Y rises from 1,200 to 1,500in response to a price reduction from £2.00 to £1.50, calculate the price elasticity of demand. 300 x 100 1200 = 25% = 1 ie unit elasticity 50 x 100 25% 200

  10. INCOME ELASTICITY OF DEMAND Measures the responsiveness of demand to changes in income > 1 is relatively income elastic < 1 is relatively income inelastic = 1 is unit income elasticity E = % change in Quantity Demanded % change in Income Products for which quantity demanded increases when income increases and vice versa have a positive(+) income elasticity value. These would be normal goods ie goods which follow the law of demand eg steak. Products for which quantity demanded increases when income decreases and vice versa have a negative (-) income elasticity value. These would be giffen goods ie of inferior quality eg sausages

  11. QUIZ Calculate the income elasticity of demand for commodity A if, in response to an increase in income of 5%, quantity demanded increases from 200 per week to 275 per week. What kind of commodityis A? + 75 x 100 200 1 = + 37.5% = + 7.5 + 5% + 5% A normal good eg biscuits What is the income elasticity of demand for commodity B if demand increases from 5,000 to 5,500 units per week when when real income falls by 2.5%. +500 X 100 5,000 1 = + 10% = - 4 -2.5% - 2.5% What kind of commodity is B? A giffen good eg bread

  12. CHANGES IN DEMAND When there is a change in a determinant of demand other than price then the demand curve shifts . If tastes change in favour of a commodity then more is demanded at all prices and the demand curve shifts forward to the right. If the price of a substitute falls then less of the commodity will be demanded at all prices and the demand curve shifts backward to the left.

  13. QUIZ Say what happens to demand in each of the following cases: The demand for a normal good when its price rises. A contraction in quantity demanded. The demand for a luxury good when its price falls. An extension in quantity demanded The demand for a giffen good when income rises. A backward shift in demand to the left. A forward shift in demand to the right. The demand for a good when the price of its complement falls. The demand for a good when the price of a close substitute rises. A forward shift in demand to the right. The demand for a good which has recently been declared bad for health. A backward shift in demand to the left.

  14. SUPPLY • the willingness to sell a commodity at a given price THE LAW OF SUPPLY More will be supplied at higher prices and less at lower prices. There is a direct relationship between price and quantity supplied resulting in a supply curve sloping upwards from left to right. A fall in price results in a contraction of supply An increase in price results in an extension of supply

  15. ELASTICITY OF SUPPLY • measures the responsiveness of supply to changes in price E = % change in Quantity Supplied % change in Price Depends on the ability of suppliers to respond to price changes therefore depends on: • the time it takes to alter production levels • availability of stocks • availability of factors of production • the ease of entry of new firms into the market An increase in costs will shift supply to the left. A decrease in costs will shift supply to the right.

  16. THE PRICE MECHANISM Prices are determined by market forces ie the interaction of supply and demand. The interaction of supply and demand determines the market clearing price ie equilibrium price – the price at which all goods supplied are demanded. Any price above this will mean excess supply which will force price down. Any price below this will mean excess demand which will push up price. Equilibrium price will change with changes in demand and/or supply in Response to changes in the determinants of demand and supply.

  17. INTERVENTION IN THE MARKET This happens when there is market failure or the price system is not working properly ie the price is too low or too high for those involved The Government may set a maximum price to protect the purchasers. If the maximum price set (Maxp) is below equilibrium price, there will be excess demand which could result in a “black market” for the commodity. The Government may set a minimum price to protect the incomes of the suppliers eg the minimum wage in the labour market. If the minimum price set (Minp) is above equilibrium price, there will be excess supply which, in the labour market, too high a minimum wage would cause unemployment.

  18. TAXES AND SUBSIDIES Intervention in the market can also be by means of government taxes and subsidies. Indirect taxes eg excise duty are placed on products in order to raise revenue for the government and/or to discourage consumption of certain commodities such as cigarettes and alcohol. Taxes have the effect of shifting the supply curve tothe left thereby increasing price. Subsidies are given to producers to encourage the production of certain products. Subsidies have the effect of shifting the supply curve to the right thereby lowering price.

  19. CHANGES IN EQUILIBRIUM PRICE Equilibrium price will change whenever there is a change in any of the determinants of demand and/or supply. Any of these changes in determinants (other than price) cause shifts in the demand and/or supply curves, altering the market clearing price. FORWARD SHIFT IN DEMAND INCREASES EQUIL PRICE BACKWARD SHIFT IN DEMAND DECREASES EQUIL PRICE FORWARD SHIFT IN SUPPLY DECREASES EQUIL PRICE BACKWARD SHIFT IN SUPPLY INCREASES EQUIL PRICE COMBINATION OF SHIFTS INCREASING EQUIL PRICE COMBINATION OF SHIFTS DECREASING EQUIL PRICE

  20. AND FINALLY …… Complements such as CDs and CD players are said to be in joint demand since one is no use without the other. Close substitutes such as butter and margerine are said to be in competitive demand since they both perform the same function and consumers will choose between them. Joint supply is where the production of one product eg oil automatically leads to the production of another eg petrol or paint or plastics Where the total supply of one commodity is fixed because of limited resources, a reduction in the supply of one necessitates the reduction of another – these are said to be in competitive supply eg milk and cheese.

  21. QUIZ What factors changes equilibrium price? Changes in any of the determinants of demand and/or supply. Give 2 examples of market intervention. The minimum wage and price capping. To encourage the consumption of some products and discourage others. Why might governments intervene in markets? Tennis racquets and tennis balls. Name 2 products in joint demand. Name 2 products in joint supply. Beef and leather Give an example of products in competitive demand. Gas and electricity Give an example of competitive supply. Land for housing and land for recreation

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