Price Determination (1.3.3)

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9 Terms

1
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Market Equilibrium

  1. Where supply meets demand

  2. Market clearing price, everything brought to market is sold



<ol><li><p>Where supply meets demand</p></li><li><p>Market clearing price, everything brought to market is sold</p></li></ol><p></p><p></p>
2
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Excess Demand (Shortage)

  1. Occurs when market price is below equilibrium price

  2. Quantity demanded is higher than quantity supplied

  3. Shortage in products causes firms to increase retail prices, causing the firms to supply more (extension) and quantity demanded contracts until P1 is reached


<ol><li><p>Occurs when market price is below equilibrium price </p></li><li><p>Quantity demanded is higher than quantity supplied </p></li><li><p>Shortage in products causes firms to increase retail prices, causing the firms to supply more (extension) and quantity demanded contracts until P1 is reached </p></li></ol><p></p>
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Excess Supply (Surplus)

  1. Occurs when market price is above equilibrium price

  2. Quantity supplied is higher than quantity demanded

  3. This causes firms to lower prices to clear stock, contraction in quantity supplied, and quantity demanded extends until P1 is reached


<ol><li><p>Occurs when market price is above equilibrium price </p></li><li><p>Quantity supplied is higher than quantity demanded </p></li><li><p>This causes firms to lower prices to clear stock, contraction in quantity supplied, and quantity demanded extends until P1 is reached </p></li></ol><p></p>
4
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Curve Shifts

  1. PIRATES (Demand Shifters) population, income, related goods, advertising, taste/fashion, expectations, season

  2. PINTSWC (Supply Shifters) productivity, indirect taxes, number of firms, technology, subsidies, weather, costs of production


5
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Commodity Markets (Cobweb Theory)

  1. Demand side, food is a necessity, making demand highly price inelastic

  2. Supply side, unstable due to weather and long time lags to grow crops

  3. Cobweb diagram, caused by information failure where farmers plan next years output based on this years prices, creating cyclical surpluses and shortages


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Wealth effect

Psychological theory, where when people’s assets rise, they feel richer, even though their income is still the same.

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Equity

How much portion you own, value of an asset - debt (e.g house 200k deposit 50k mortgage 150k, 200k - 150k =50 K 50k equity)

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Housing Market (Wealth Effect)

  1. Driven by wealth effect when house prices rise ratio of house value to mortgage debt increases customer equity

  2. This makes consumers feel wealthier, increasing consumer confidence/spending shifting aggregate demand curve to right


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Limitations of Supply & Demand models

  1. Asymmetric information, the model assumes perfect info, when in reality, consumers and producers don’t know all the information, or the info is imperfect.

  2. Irrational behaviour, assumes consumers act rationally to maximise utility, which is not always the case

  3. Veblen paradox, assumes demand falls when price increases, but sometimes consumers buy more as price increases (higher quality products)

  4. Ceteris paribus, can only isolate and show certain markets at one time.