Unit 2 - How Markets Work

resource allocation

what to produce, for whom to produce, how to produce

3 economic systems

free market, mixed, planned/command

free market economic system

Economic system where the individual consumers, firms, and households will determine the allocation of resources. There is a limited role for a government, meaning no tax or public spending. Controlled by the market of demand and supply. Ex. Singapore, Taiwan, Ireland.

planned economic system

Economic system where only the government controls the allocation of resources. Individual consumers, firms and households have little control over the allocation of resources. Ex. North Korea

mixed economic system

Combination of private and government ownership/control on the allocation of resources. Ex. Iceland, Slovakia, Romania.

demand

Demand is the consumers ability and willingnesss to purchase a good or service at a given price.

quantity demanded

amount of good or service that consumers are willing to purchase ast every given price

law of demand

The Law of Demand states that if the price of a good or service increases, then the quantity demanded of that good or service will decrease. There is an inversely proportional relationship between price and quantity demanded.

extension (demand)

downward line

contraction (demand)

upward line

non-price factors of demand

consumer income, income tax, complementary goods, substitute goods, changes in preferences, and population

normal goods

goods whose demand will increase when income increases

inferior goods

goods whose demand will decrease when income increases

change in consumer income how it impacts demand

As consumer's income increases, their ability to purchase is likely to increase (normal goods), shifting the curve to the right.

change in tax on income effect on demand

As taxes increase, the consumer's disposable income will decrease, therefore their ability to purchase goods will decrease.

complementary goods impact on demand

Goods whose use is related to the use of an associated good. So, when one good's price increases, then the demand for the complementary good will decrease.

substitute goods impact on demand

Goods that can replace the want for a different good/service. When a price of one good increases, the demand for its substitute good will increase.

change in preferences impact on demand

In favor of product -> Demand increases -> shift R In favor of alternative -> Demand decreases -> shift L

population impact on demand

Population increase -> Demand increases -> Shift R Population decreases -> Demand decreases -> Shift L

supply

Amount of good or service firms or producers are willing to make, sell, and produce at a given price and given time.

law of supply

As the price of a good or service increases/rises, the quantity supplied of the good will rise. They are directly proportional. This is because producers are willing to supply more as they can sell it at higher prices.

extension supply

upward line

contraction supply

downward line

non-price factors of supply

cost of fop, innovation in tech, taxes, government support

cost of fop impact on supply

Increase costs -> supply decrease -> Shift left

Decrease costs -> Supply increase -> Shift right

innovation in tech impacts on supply

Will help speed up process and reduce costs of FOP.

COP decrease -> Supply increase -> Shift right

gov taxes impact on supply

Tax increase -> COP increase -> Supply decrease -> Shift left

equillibrium

When quantity supplied and quantity demanded are equal. There is no excess supply or excess demand

excess supply

Also known as surplus When quantity supplied is higher than quantity demanded.

Excess Demand

Also known as shortage When quantity demanded is higher than quantity supplied.

ped definition

PED refers to the price elasticity of demand. It is the measure of the responsiveness of the quantity demanded of a good to a chang in price.

PED formula

% change in QD / % change in price

what happens when ped is greater and less than 1

greater → elastic

less → inelastic

elastic demand + line + example

change in demand is greater than change in price. Flatter. restaurant meals → non-essential since there are many substitutes

inelastic demand + line + example

change in demand is less than change in price. steeper

cigarettes → addiction

formula for percentage change in quantity demanded

change in quantity / original quantity x 100

formula for percentage change in price

change in price / original price x 100

ped formula

% change in quantity demanded / % change in price

merit goods definition + what type of good are they

Goods that positively impact both society and the consumer. For example, healthcare, and education.

Merit goods are inelastic goods since they are often essential and people consume them regardless of price. They also lack close substitutes, hence considered inelastic.

demerit goods definition + what type of good are they

Demerit goods are goods that negatively impact both society and the consumer. For example smoking, and alcohol.

Demerit goods are elastic because they have many substitutes, making consumers less likely to continue consuming when prices rise. They're also non-essential, so people can easily stop consuming if the price rises.

how to boost revenue for elastic demand

to boost revenue, producers should decrease price since it leads to a more than proportionate increase in quantity demanded, leading to increased revenue

how to boost revenue for inelastic demand

To boost revenue, producers should increase prices to increase revenue since it leads to a larger than proportionate increase in quantity demanded. This is due to the lack of responsiveness from the consumer even if the price increased.

determinants of ped

necessity, substitutes, habit consumption, cost to switch suppliers, proportion of income

how does necessity impact PED?

Products that are necessities are more price inelastic due to the difficulty to go without necessary items.

Additionally, consumers are unlikely to buy significantly more inelastic goods if prices fall.

Products that are luxuries are more price elastic due to the ability to easily delay or reduce the purchases of non-essential goods if prices rise.

Consumers are able to go without these goods for long periods of time since they are not essential for survival.

Consumers are more likely to buy elastic goods if prices fall due to the availability of substitutes and the discretionary nature of spending on these items.

how does substitutes impact PED

Products that have many substitutes, demand is likely to be elastic.

Because consumers can switch with ease if prices rise.

Products that have little substitutes are inelastic

how does habit consumption impact ped

Goods associated with habit consumption tend to be more inelastic because consumers are used to buying a product regularly, hence they continue to purchase with price changes.

ie. cigarettes, coffee, toothpaste.

Goods that aren't habitually consumed are elastic since consumers are likely to evaluate the price and switch to alternatives if prices rise.

How does switching suppliers impact PED?

Even if goods are cheaper, breaking contact with the existing supplier may cost more.

How does the proportion of income the good takes impact PED?

Goods are elastic if the good takes a larger proportion of a consumer's income since consumers are more sensitive to price changes and likely to delay purchases if prices rise.

If the value of PED is 0, what does that mean?

Perfectly Inelastic

Straight up like y axis

Quantity demanded is completely unresponsive to change in price

If the value of PED is 0-1, what does that mean?

Relatively inelastic

Steep line

% change in quantity demanded is less than proportional to % change in price.

If the value of PED is 1, what does that mean?

Unitary elastic

hyperbola line

% change in quantity demanded is equal to % change in price

If the value of PED is 1-infinity, what does that mean?

Relatively elastic

Flatter line

% change in quantity demanded is more than proportional to % change in price.

If the value of PED is infinity, what does that mean?

Perfectly elastic

Straight line (x axis)

% change in quantity demanded will fall to zero with any % change in price.

Consumers will only buy products at a specific price.

definition of pes

PES refers to the price elasticity of supply. It is the measure of the responsiveness of quantity supplied to a change in price of a good or service

inelastic supply + line + example

change in qs is smaller than change in price. line is steeper. art (since artists died, cannot produce new copies)

elastic supply + line + example

Change in quantity supplied is greater than change in price. The line is flatter. canned food, easier to produce/store

determinants of pes

Availability of stock/storage, Spare capacity, Time period, Mobility and availability of FOP

How does the availability of stock/storage impact PES?

When firms hold high levels of inventory, they can respond quickly to increases in price by supplying more goods without delays.

When firms hold low levels of inventory or goods are made to order, firms cannot immediately increase output, making it difficult to respond to price changes.

How does spare capacity impact PES?

If a firm has spare productive capacity (unused machinery, underutilized labor) it can increase output quickly when prices rise.

If a firm was operating at full capacity, any attempt to increase supply may involve high costs or capacity investment making it harder to adjust.

How does time period impact PES?

In the short run, at least one FOP is fixed, meaning firms cannot easily adjust output levels.

In the long run, firms can obtain more FOP to expand their scale of production.

How does mobility+availability of FOP impact PES?

If FOPs are highly mobile and readily available, firms can reallocate resources efficiently and increase output in response to higher prices.

If FOPs are immobile, firms struggle to increase production in the short term.

actions for pes

Increases storage to keep stocks of products

Invest in additional productive capacity

Employ latest production equipment and processes

Train workers in new skills to be more mobile

What are primary goods?

Raw materials or natural resources that are extracted or harvested from nature. They haven't been manufactured or processed. They tend to be inelastic in supply since it would take time to reallocate FOP. ie. build oil-rigs, mines

What are secondary goods?

Goods that have been processed or made from raw materials using labor and machinery. They tend to have a more elastic supply due to the ease in changing production to make different products and the likelihood of unused capacity.

If the value of PES is 0?

Perfectly inelastic

Straight up (y axis)

QS remains completely unresponsive to changes in price.

fixed off seats in a theatre.

If the value of PES is 0-1?

Relatively inelastic

Steep line

% change in QS is less than proportional to % change in price.

For example, agricultural products.

If the value of PES is 1- infinity?

Relatively elastic

flatter line

% change in QS is greater than proportional to % change in price.

If the value of PES is infinity?

Perfectly elastic

% change in QS will fall to zero at any % change in price while supply is unlimited at a particular price.

If the value of PES is 1?

Unitary elastic

Straight line from origin.

% change in QS is exactly equal to % change in price.