How markets work (1.2)

What consumers do

Maximise utility

What producers do

Maximise profit

What government does

Maximise welfare

Demand

The quantity of a good/service that consumers are able and willing to purchase at a given price in a given period of time.

The Law of Demand

There is an inverse relationship between price and quantity demanded. As price of a good/service increases, quantity demanded decreases and vice versa, assuming ceteris paribus.

Moving up the demand curve

Contraction of demand

Moving from b to a

Contraction of demand

Moving down the demand curve

Extension of demand

Moving from a to b

Extension of demand

Reasons for downward sloping demand curve

• Income effect

• Substitution effect

Both cause movement along the curve

Non-price factors affecting demand

Population

Advertisement

Substitutes price

Income

Fashion/trends

Interest rates

Complements price

Price elasticity of demand

How responsive the quantity demanded of a product is given a change in price

Equation of PED

Is PED always negative or positive

Negative

Why PED is always negative

The law of demand - Price and quantity demanded have a negative/inverse relationship

PED >1

Demand is price elastic

PED <1

Demand is price inelastic

PED = 0

Demand is perfectly price inelastic

PED = infinity

Demand is perfectly price elastic

PED = 1

Demand is unitary/ unit price elastic

Label the type of elasticity of the demand curves and what their PED would be

Label the type of elasticity of the demand curves and what their PED would be

Factors affecting PED

Substitutes (no.)

Percentage of income

Luxury/necessity

Addictive/habit forming

Time period

Income elasticity of demand (YED)

Measures the responsiveness of the quantity of a good/service demanded given a change in income

Equation of YED

What YED helps us determine about a good

Whether the good is a normal good or an inferior good

Normal good

Positive relationship between income and demand

Inferior good

Inverse relationship between income and demand

YED for normal goods

Positive YED

YED for inferior goods

Negative YED

Normal good where YED >1

Demand is income elastic and it is a normal luxury good

Normal good where YED <1.

Demand is income inelastic and it i a normal necessity

Inferior good where YED >1

Demand is income elastic

Inferior good where YED <1

Demand is income inelastic

YED = 0

Demand is perfectly inelastic

Label the type of elasticity of the demand curves and what their YED would be

Normal goods

Label the type of elasticity of the demand curves and what their YED would be

Inferior goods

Cross elasticity of demand (XED)

Measures the responsiveness of quantity demanded of a good/service given a change in price of another good/service

What XED is used to figure out

Whether two goods have any relation to each other(substitute or complementary) and how strong this relation is.

Equation of XED

Positive XED

Substitute goods

Negative XED

Complementary goods

XED without sign >1

Demand between the goods/services is price elastic and the goods/services are strongly related

XED without sign <1

Demand between the goods/services is price inelastic and the goods/services are weakly related

XED without sign = 0

Demand between the goods/services is perfectly price inelastic and the goods/services have no relationship

Label the type of goods shown by the graph and what the XED of the demand curves would be

PED’s cruciality in businesses

Helps businesses make pricing decisions to increase their total revenue

Equation for Total revenue

Relationship between PED and price changes, with total revenue

Elastic - Elastic

Only - Opposite

Irritates - Inelastic

Skin - Same

Affect on total revenue if the price is increased for an elastic good

Total Revenue decreases

Affect on total revenue when the price is decreased for an elastic good

Total Revenue increases

Affect on Total Revenue when the price is increased for an inelastic good

Total Revenue increases

Affect on the Total Revenue when the price for and inelastic good is decreased

Total Revenue decreases

The type of elasticity this good has and what the green section represent

Elastic good and the section represents Revenue gained

The type of elasticity this good has and what the blue section represent

Elastic and the section represents the initial revenue

The type of elasticity this good has and what the purple section represent

Elastic and the section represents the New revenue

The type of elasticity this good has and what the red section represent

Elastic good and the section represents Revenue lost

The type of elasticity this good has and what the green section represent

Inelastic and the section represents revenue gained

The type of elasticity this good has and what the red section represent

Inelastic and the section represents revenue lost

The type of elasticity this good has and what the blue section represent

Inelastic and the section represents the initial revenue

The type of elasticity this good has and what the purple section represent

Inelastic and the section represents the new revenue

Supply

The quantity of a good/service that producers are willing and able to produce at a given price in a given time period

Law of supply

There is a positive relationship between price and quantity supplied. As price increases, quantity supplied increase and vice versa, assuming ceteris paribus

Moving from a to b

Extension of supply

Moving from b to a

Contraction of supply

Why there is a positive relationship between price and supply

Profit motive

• When price increases producers produce more to increase profit

• When quantity increases, producers increase the price of the goods or service to account for production costs and to increase profit

Non-price factors affecting supply, shifting the supply curve

Productivity

Indirect tax

No. of firms

Technology

Subsidies

Weather

Costs of production

Price elasticity of supply (PES)

Measures the responsiveness of quantity supplied to a given change in price

Equation of PES

Is PES always negative or positive

PES is always positive

Th reason why PES is always positive

The Law of Supply - There is a positive relationship between price and quantity supplied

PES >1

Supply is price elastic

PES <1

Supply is price inelastic

PES = infinity

Supply is perfectly price elastic

PES = 0

Supply is perfectly price inelastic

PES = 1

Supply is unitary/unit price elastic

Label the type of elasticity of the supply curves and what their PES would be

Label the type of elasticity of the supply curves and what their PES would be

Features affecting PES

Production lag

Stocks

Spare capacity

Substitutability of F.O.Ps

Time

Problems with using elasticity when making decisions

• Elasticity is only an estimate through surveys, competitors and past data

• Elasticity assumes ceteris paribus meaning that other factors are ignored

• PED varies along the demand curve

Direct tax

Tax on income that cannot be transferred

Indirect tax

Expenditure tax that increases the costs of production for firms that can be then transferred onto consumers via higher prices

Two types of indirect tax

Specific and AD valorem

Specific indirect tax

Tax per unit

Ad valorem

Tax as a percentage of the price being charged

Identify the type of indirect tax this is and add necessary labels

Specific indirect tax

Identify the type of indirect tax this is and add necessary labels

Ad valorem tax

Impact of indirect tax on the supply curve

Shifts upwards

Impact of indirect tax on price and quantity

Price increases and quantity decreases

Fully label this graph

Working out government revenue from supply and demand graph

Consumer burden

The amount of government tax revenue that is received by the government from consumers

Producer burden

The amount of government tax revenue that is received from producers

Calculating producer revenue from supply and demand graph

Consumer burden when producing a price elastic good with tax compared to producing a price inelastic good

Consumer burden is Lower

Producer burden when producing a demand price elastic good with tax compared to producing a demand price inelastic good

Producer burden is higher

Government revenue when producing a demand price elastic good with tax compared to producing a demand price inelastic good

Government revenue is lower

Consumer burden when producing a supply price elastic good with tax compared to producing a supply price inelastic good

Consumer burden is higher

Producer burden when producing a supply price elastic good with tax compared to producing a supply price inelastic good

Producer burden is lower

Subsidy

A money grant to firms given by the government to reduce cost of production and encourage an increase in output