Economics 1.2

Study Area 2: Demand, Supply, Market Equilibrium, Resource Allocation in a Market Economy, Price Elasticity of Demand (PED)

Demand

The willingness and ability of consumers to purchase a quantity of a good or service at various prices during a period of time, ceteris paribus.

Law of Demand

Price and Quantity Demanded have an inverse relationship.

Demand Non-P Factors

Expectations of future prices
Government policies

Yincome

Price of related goods/population size
Taste and preferences

DD Expansion

↑Qdd, due to ↓P

DD Contraction

↓Qdd, due to ↑P

DD Increase

Rightward shift of DD curve, due to non-p factor

DD Decrease

Leftward shift of DD curve, due to non-p factor

Supply

The willingness and ability of producers to sell a quantity of a good or service at various prices during a period of time, ceteris paribus.

Law of Supply

Price and Quantity Supplied have a direct relationship.

Supply Non-P Factors

Weather
Expectations of future prices
Technology
Price of related goods
Input prices
Government policies
Supply shocks / number of Sellers

SS Expansion

↑Qss, due to ↑P

SS Contraction

↓Qss, due to ↓P

SS Increase

Rightward shift of SS curve, due to non-p factor

SS Decrease

Leftward shift of SS curve, due to non-p factor

Qs>Qd

Surplus, downward pressure on price

Qd>Qs

Shortage, upward pressure on price

↑DD

↑P, ↑Q

↓DD

↓P, ↓Q

↑SS

↓P, ↑Q

↓SS

↑P, ↓Q

Resource Allocation in a Market Economy

Resource Allocation is determined by the interaction of firms and consumers under the guidance of the price mechanism.

Consumer sovereignty

Consumer preferences and demand for products influence and determine how resources are allocated in a market-based economic system.

Derived Demand

The demand for a factor of production/resource is driven by the demand for another consumer good.

When firms demand more of the resources used to create high demand products.

Price Elasticity of Demand (PED)

The degree of responsiveness of the quantity demanded of a good for a given change in price, ceteris paribus.

PED formula

PED = %△Qdd/%△P

%△Qdd = Qdd2-Qdd1 / (Qdd1+Qdd2)/2

%△P = P2-P1 / (P1+P2)/2

PED Factors

Time period
proportion of Income
Nature of good (degree of necessity)
no. and closeness of Substitutes

|PED|>1

Elastic demand
△P→MTP△Qdd

↑P↓TR ; ↓P↑TR

|PED|<1

Inelastic demand

△P→LTP△Qdd

↑P↑TR ; ↓P↓TR

Revenue Maximization

PED is unit elastic - %△Qdd > %△P