eco
Eduvos: Economics Study Notes
Learning Outcomes
Understand the term ‘competitive markets’.
Define the law of demand, understand the difference between demand and quantity demanded, and describe the factors that influence demand.
Define the law of supply, understand the difference between supply and quantity supplied, and describe the factors that influence supply.
Understand and define economic concepts such as ‘equilibrium’ and ‘ceteris paribus’; explain how demand and supply determine prices and quantities being bought and sold.
Utilize demand and supply functions to make predictions about changes in prices and quantities.
Markets and Prices Recap
People make decisions to cope with scarcity. Their choices respond to incentives.
Prices act as incentives.
People respond to prices, and prices are determined by demand and supply (the price mechanism).
A market is where goods and services are bought and sold.
It involves any arrangement that enables buyers and sellers to get information and transact.
Markets are two-sided, consisting of producers and consumers.
Examples of different markets:
Johannesburg Stock Exchange (JSE)
Produce Markets
Online retail platforms such as Takealot
Competitive Markets
Competitive markets have many buyers and sellers.
In these markets, no single buyer or seller can influence the price.
Producers sell items at prices that cover their opportunity costs.
Consumers seek cheaper alternatives in response to changing opportunity costs.
Opportunity Cost: The highest valued alternative forgone by choosing one option over another.
Money Price: The price of an object expressed in currency, such as Rands.
Example:
If the money price of coffee is $1 and the price of gum is $0.50, the opportunity cost of one cup of coffee is two packs of gum.
Calculated as:
Thus, the relative price of one cup of coffee is 2 packs of gum.
Demand
Definition
Demand exists if the consumer:
Wants the good or service.
Can afford it.
Plans to buy it.
Quantity Demanded: The amount consumers plan to buy during a specified time period at a particular price.
A demand curve reflects willingness and ability to pay, representing marginal benefit.
Law of Demand
Ceteris Paribus: If everything else remains the same, the higher the price, the lower the quantity demanded; and vice versa.
This implies an Inverse Relationship:
When Price ↑, Demand ↓
When Price ↓, Demand ↑
Reasons for Demand Changes
Substitution Effect:
As prices rise, the incentive to switch to substitutes increases because the relative price (opportunity cost) of the original good has increased.
Income Effect:
When prices rise without any change in income, individuals cannot buy the same quantity of goods due to reduced purchasing power.
Demand Curve Attributes
Demand represents the entire relationship between price and quantity demanded.
Illustrated using a demand curve derived from a demand schedule.
Quantity demanded correlates to points on the demand curve.
The demand curve slopes downward due to the inverse relationship between price and quantity demanded.
Changes in Demand
Movements along the Demand Curve:
A movement occurs due to price changes.
An increase in price results in an upward movement, decrease in price results in a downward movement.
Only the selling price causes these movements.
Shifts of the Demand Curve:
Determinants:
Prices of substitutes/related goods
Expected future prices
Income
Expected future income and credit
Population
Preferences
A leftward shift indicates a decrease in demand; a rightward shift indicates an increase in demand.
Demand shifts due to factors other than price.
Determinants of Shifts in the Demand Curve
Prices of Substitutes or Related Goods:
Substitutes replace each other; complements are used together.
Expected Future Prices:
Higher expected prices lead consumers to buy now rather than later to avoid higher costs.
Income Changes:
Normal goods see increased demand with rising incomes; inferior goods see decreased demand.
Expected Future Income and Credit:
Positive changes in future income expectations or easier credit access can boost demand immediately.
Population Changes:
As population increases, demand for all goods generally rises; a smaller population equals lower demand.
Preferences:
Individual likes and dislikes directly impact demand for goods and services.
Movements vs Shifts in Demand
Movement from one point to another on the demand curve indicates a change in quantity demanded due to price change.
Shift represents a change in demand due to factors like preferences or income shift, without a price change.
Supply
Definition
A firm supplies a good/service when it:
Has resources and technology to produce it.
Can profit from producing it.
Plans to sell it.
Quantity Supplied: The amount a producer is willing to sell at a specific price during a fixed time period.
Law of Supply
Ceteris Paribus: Higher prices lead to an increased quantity supplied, while lower prices lead to a decreased quantity supplied, indicating a Positive Relationship.
A higher price incentivizes greater production as firms seek profit.
The Marginal Cost explains why supply curves slope upward: increasing prices lead firms to accept higher marginal costs.
Supply Curve Attributes
The supply curve shows the entire relationship between price and quantity supplied.
Quantity supplied represents points on the supply curve, with the supply schedule indicating the amount supplied at various prices.
Minimum Supply Price
The supply curve acts as a minimum supply price curve; it shows the lowest price required to sell additional units, which reflects marginal cost.
Changes in Supply
Movements along the Supply Curve:
Caused solely by price changes:
An increase in price leads to an upward movement along the supply curve.
A decrease in price leads to a downward movement along the supply curve.
No other factors affect movements along the curve.
Shifts of the Supply Curve:
Determinants:
Prices of factors of production
Prices of related goods produced
Expected future prices
Number of suppliers
Technology changes
Natural state of factors affecting production
Leftward shifts signal decreased supply; rightward shifts signal increased supply.
Market Equilibrium
Equilibrium occurs when the price balances demand and supply.
Equilibrium Price: The price at which quantity demanded equals quantity supplied.
Equilibrium Quantity: The amount bought and sold at equilibrium price.
Market adjustments occur based on excess supply or demand, leading to iterative price changes until equilibrium is found.
Surpluses lead to price drops; shortages lead to price increases.
Market Equilibrium Example
If price is high, quantity supplied exceeds quantity demanded (surplus). The price will reduce until reaching equilibrium. Conversely, if the price is too low, quantity demanded exceeds quantity supplied (shortage), and prices will rise to reach equilibrium.
Predicting Changes in Price and Quantity
Changes in Demand:
Rightward shift (increase) creates a shortage, causing prices to rise.
Leftward shift (decrease) creates a surplus, causing prices to fall.
Changes in Supply:
Rightward shift (increase) creates a surplus, causing prices to decrease.
Leftward shift (decrease) creates a shortage, causing prices to increase.
Interactions of Supply and Demand Changes
When demand and supply change in the same direction, the equilibrium quantity changes; the price also changes based on the relative magnitude of shifts.
When demand and supply change in opposite directions, equilibrium quantity direction follows the larger change. Predicting exact price changes requires knowing both magnitude and direction of shifts.
Mathematical Example
Example:
Demand:
Supply:
To find equilibrium, set them equal:
This simplifies to find and , leading to an equilibrium price of $4 per cone.