Economic Issues: An Introduction DE3A 34

1. Economic Issues: An Introduction DE3A 34 Outcome 1 Topic 5 Interaction within the Market

2. Price determination in the market • Prices are determined by demand and supply interacting with one another. • Where the demand and supply meet in a market gives the market or equilibrium price. • This can be illustrated by using a combined demand and supply schedule .

3. Demand and supply • Markets exist for the vast majority of goods and services. • Prices usually play an important role in these markets. • Price is determined by demand and supply. • The equilibrium price is where demand equals supply. • At this point there are no forces causing the price to change.

4. Price per pack (£) Quantity Demanded (Packs per week) Quantity Supplied (Packs per week) 1.60 60 19 1.80 55 30 2.00 49 40 2.10 45 45 2.20 40 49 2.30 30 55 2.50 19 60 Equilibrium • We shall use the prawn mayonnaise sandwiches example again. Demand and supply schedule for prawn mayonnaise sandwiches.

5. Equilibrium • From the table above we can see that equilibrium occurs at the price £2.10 where the quantity supplied and the quantity demanded are both equal at 45 packs per week. • We can also see equilibrium if we sketch a graph of a demand and supply curve for prawn mayonnaise sandwiches.

6. Price equilibrium for prawn mayonnaise sandwiches We can see from the graph above that the equilibrium price occurs at £2.10 and equilibrium quantity supplied at 45 packs per week. S Price (£) £2.10 D 0 45 Quantity Packs/Week

7. The equilibrium price Here we have a supply and a demand curve for a particular market. What is the equilibrium price? Price 1 (P1)? Price 2 (P2)? Price 3 (P3)? Price S1 P1 P3 P2 D1 0 Quantity

8. Price 1 (P1)QD < QS Quantity demand is less than quantity supplied, there is downwards pressure on price. A buyer’s market. Q.There will be a tendency for the price to fall from this level P1 – why? Price S1 A. The quantity supplied is greater than the quantity demanded hence the price will fall to reduce surplus quantity supplied. P1 D1 0 QD QS Quantity

9. Price 2 (P2)QS < QD Quantity supplied is less than quantity demanded. Upwards pressure is put on price. A seller’s market. Q. Price will tend to rise from this level P2 – why? Price S1 A. The quantity supplied is less than the quantity demanded, hence the price will rise as suppliers maximise their profits. P2 D1 0 QS QD Quantity

10. Price 3 (P3)QS = QD Quantity supplied is equal to quantity demanded. Equilibrium price has been dictated, no pressure on price to move. Price Conclusion: price will eventually settle at P3 – why? S1 P3 A. The price will be stable, in equilibrium, when quantity supplied = quantity demanded. D1 0 QS QD Quantity

11. Changes in market equilibrium • Under certain circumstances the market equilibrium in a market will change. • Changes in the conditions of demand or supply will lead to a change in market equilibrium.

12. Changes in market equilibriumChanges in the condition of demand (1) • Increase in demand moves the entire demand curve to the right D1 to D2 • Equilibrium price (EP) has increased from P1Q1 to P2Q2 • An increase in demand has increased the EP to EP1 Price S1 P2 P1 EP1 EP D2 D1 0 Q1 Q2 Quantity

13. Explanation of graph • This will affect demand. • It will increase demand at each and every price so the demand curve will shift to the right and the equilibrium price will increase as will the equilibrium quantity. • A shortage has been created. • Prices in the market rise and this encourages suppliers to supply more. • There is an extension in supply and the price mechanism has acted to allocate resources towards making this product.

14. Changes in market equilibrium Changes in the condition of demand (2) • Decrease in demand moves the entire demand curve to the left • Equilibrium price (EP) has decreased from P1Q1 to P2Q2 • An decrease in demand has decreased the EP to EP1 Price S1 P1 P2 EP EP1 D1 D2 0 Q2 Q1 Quantity

15. Explanation of graph • The previous diagram shows that the fall in demand has resulted in a surplus (there is more quantity supplied than demanded) arising in the market at the old price with the new demand . • There is pressure on prices to fall and as a result of the falling price resources are allocated away from making this good . • There is a contraction in supply along the supply curve.

16. Changes in market equilibrium Changes in the condition of supply (1) • Increase in supply moves the entire supply curve to the right. • Equilibrium price (EP) has fallen from P1Q1 to P2Q2 • An increase in supply has decreased the EP to EP1 Price S1 S2 P1 P2 EP EP1 D1 0 Q1 Q2 Quantity

17. Explanation of graph • Supply has increased at every price. • An increase in supply has moved the supply curve to the right. • A surplus has been created as supply outstrips demand. • Equilibrium price will fall to clear the surplus supply. • Demand will extend along the demand curve reacting to the fall in price.

18. Changes in market equilibrium Changes in the condition of supply (2) • Decrease in supply moves the entire supply curve to the left. • Equilibrium price (EP) has risen from P1Q1 to P2Q2 • An decrease in supply has increased the EP to EP1 Price S2 S1 P2 P1 EP1 EP D1 0 Q2 Q1 Quantity

19. Explanation of graph • Supply has decreased at every price. • An decrease in supply has moved the supply curve to the left. • A shortage has been created as demand outstrips supply. • Equilibrium price will rise due to the shortage of supply. • Demand will contract along the demand curve reacting to the increase in price.

20. Supply and Demand • Examples 1 - 12 • Produce a graph and explanation for the following examples.

21. Example 1 • During hot weather in summer the demand for ice cream increases. Show an increase in demand on the following graph, and provide an explanation: S1 Price D1 0 Quantity

22. Answer • Increase in demand moves the entire demand curve to the right D1 to D2 • Equilibrium price (EP) has increased from P1Q1 to P2Q2 • An increase in demand has increased the EP to EP1 Price S1 P2 P1 EP1 EP D2 D1 0 Q1 Q2 Quantity

23. Example 2 • As a result of recently published medical research into the effects of smoking cigarettes, the demand for cigarettes has fallen. Show a decrease in demand on the following graph and provide an explanation: Price S1 D1 Quantity 0

24. Answer • Decrease in demand moves the entire demand curve to the left • Equilibrium price (EP) has decreased from P1Q1 to P2Q2 • An decrease in demand has decreased the EP to EP1 Price S1 P1 P2 EP EP1 D1 D2 0 Q2 Q1 Quantity

25. Example 3 • New oil fields in the Atlantic Ocean are now operational. This will result in increased supply. Show an increase in supply on the following graph and provide an explanation: Price S1 D1 Quantity 0

26. Answer • Increase in supply moves the entire supply curve to the right. • Equilibrium price (EP) has fallen from P1Q1 to P2Q2 • An increase in supply has decreased the EP to EP1 Price S1 S2 P1 P2 EP EP1 D1 0 Q1 Q2 Quantity

27. Example 4 • Closing oil fields in the North sea will result in a decrease in the supply of oil. Show a decrease in supply on the following graph and provide an explanation. S1 Price D1 Quantity 0

28. Answer • Decrease in supply moves the entire supply curve to the left. • Equilibrium price (EP) has risen from P1Q1 to P2Q2 • An decrease in supply has increased the EP to EP1 Price S2 S1 P2 P1 EP1 EP D1 0 Q2 Q1 Quantity

29. Example 5 • During poor weather in summer the demand for foreign holidays increases. Show an increase in demand on the following graph, and provide an explanation. Price Quantity 0

30. Example 6 • As a result of recently published medical research into the effects of drinking and driving, the demand for alcoholic beverages has fallen. Show a decrease in supply on the following graph and provide an explanation. Price Quantity 0

31. Example 7 • When new and more efficient machines are purchased this cuts costs and increases supply. Show an increase in supply on the following graph and provide an explanation. Price Quantity 0

32. Exercise 8 • When employees strike this decreases supply of goods and services. Show an decrease in supply on the following graph and provide an explanation. Price Quantity 0

33. Exercise 9 • As a result of an advertising campaign promoting healthy eating, people are demanding more brown bread. Show an increase in demand on the following graph, and provide an explanation. Price Quantity 0

34. Exercise 10 • As a result of exceptionally hot weather, the normal demand for umbrellas has fallen. Show a decrease in demand on the following graph and provide an explanation. Price Quantity 0

35. Exercise 11 • As a result of employing more workers, the production of widgets has increased. Show an increase in supply on the following graph and provide an explanation. Price Quantity 0

36. Exercise 12 • An increase in fertiliser costs has pushed up the production costs of carrots. Show a decrease in supply on the following graph and provide an explanation. Price Quantity 0

37. Further Study • Revision Notes • Bized • The following link will take you to an interactive course leading through all aspects of market interaction. • The Nature of Markets

38. Exercise: Explanation: Price 0 Quantity