Transcript LEARNING OUTCOME 2 & 3 - Bannerman High School

LEARNING OUTCOME 2 & 3
DEMAND AND SUPPLY
DEMAND
EFFECTIVE DEMAND
•
desire to purchase backed by the ability to pay
DETERMINANTS OF DEMAND:
 Price
 Tastes
 Income
 Fashion
 Advertising
 Availability and price of substitutes
 Price of compliments
 Time of year
 Consumers’ expectations
 Availability of credit
 Population
 Utility yielded
UTILITY
UTILITY
• the satisfaction which we obtain from goods and services
MARGINAL UTILITY
• the satisfaction obtained from the last unit
• will diminish with each successive unit consumed - the law of diminishing
marginal utility
TOTAL UTILITY
• the satisfaction obtained from all units consumed
CONSUMER OPTIMUM
• maximising total utility - the theory of equi-marginal returns:
MU A = MU B = MU C = MU n
Price A
Price B
Price C
Price n
THE LAW OF DEMAND
More will be demanded at lower prices and less at higher price.
Reasons for slope of Demand Curve:
Price
P1
P
D
Q1
Q
• Law of Diminishing Marginal Utility
• Substitution Effect
• Income Effect
Quantity
When price rises from P to P1 quantity demanded contracts
from Q to Q1.
Price
P
When price falls from P to P2
quantity demanded extends
from Q to Q2
P2
D
Q
Q2
Quantity
QUIZ
What is meant by effective demand?
Name any 4 determinants of demand
How do we refer to the satisfaction
yielded by the last unit consumed?
Wants backed up by money
Price, tastes, availability of substitutes
and the price of compliments
Marginal Utility
What happens to satisfaction as we
consume more of a commodity?
Marginal utility decreases with each
unit consumed
How can individuals maximise their
total satisfaction?
By equalising the marginal utility: price
ratio for all goods consumed
Describe the relationship between
price and quantity demanded.
It is an inverse relationship
What explains this relationship?
Law of Diminishing Marginal Utility
The Substitution Effect
The Income effect
What happens on the demand curve
when price rises?
What happens on the demand curve
when price falls?
There is a contraction of demand
There is an extension of demand
PRICE ELASTICITY OF DEMAND
Measures the responsiveness of demand to price changes
E = % change in Quantity Demanded
% change in Price
Price
D
Quantity Demanded
> 1 is relatively price elastic
< 1 is relatively price inelastic
= 1 is unit price elasticity
Products which are price elastic have a
relatively flat demand curve so that in
response to even a relatively small price
change, quantity demanded changes more
than in proportion to price.
Products which are price inelastic
have a relatively steep demand
curve so that even relatively large
price changes generate
proportionately smaller changes in
quantity demanded.
Price
D
Quantity Demanded
PRICE ELASTICITY OF DEMAND
With straight line demand curves elasticity will vary along the length of the curve.
E=% Change in Quantity Demanded
% Change in Price
5
4
10 x 100
10
= 100%
1 x 100 = 20% = 5
5
Relatively Elastic
3
2
1
D
10 x 100
40
= 25%
1 x 100 = 50% = 0.5
2
Relatively Inelastic
10 20 30 40 50 60
Perfectly Elastic Demand
Perfectly Inelastic Demand
Price
Price
D
D
Quantity Demanded
Quantity Demanded
PRICE ELASTICITY OF DEMAND
When using the formula for price elasticity of demand, the sign
is assumed to be negative (-).
This is because normal goods follow the law of demand and have a
normal, downward sloping demand curve.
Products whose quantity demanded increases when price increases
would give a positive (+) value for price elasticity and have an
exceptional demand curve.
If a positive (+) value is obtained this is an exceptional good – one
which does not follow the law of demand ie one which has an
exceptional demand curve.
An example of this could be the demand for a painting by a particular
artist, which only becomes desirable as an investment by a collector,
when the price starts to rise.
QUIZ
What is the price elasticity of demand if the price of
Commodity X rises from 80p to 85p and, as a result, the demand
falls from 100 per week to 75 per week?
25 x 100
100 1
5 x 100
80
1
= 25% = 4 ie fairly elastic
6.25%
If the demand for commodity Y rises from 1,200 to 1,500 in response
to a price reduction from £2.00 to £1.50, calculate the price
elasticity of demand.
300 x 100
1200
= 25% =
50 x 100
25%
200
1 ie unit elasticity
INCOME ELASTICITY OF DEMAND
Measures the responsiveness of demand to changes in income
E = % change in Quantity Demanded
% change in Income
> 1 is relatively income elastic
< 1 is relatively income inelastic
= 1 is unit income elasticity
Products for which quantity demanded increases when income
increases and vice versa have a positive(+) income elasticity value.
These would be normal goods ie goods which follow the law of demand
eg steak.
Products for which quantity demanded increases when income
decreases and vice versa have a negative (-) income elasticity value.
These would be giffen goods ie of inferior quality eg sausages
QUIZ
Calculate the income elasticity of demand for commodity A if, in
response to an increase in income of 5%, quantity demanded
increases from 200 per week to 275 per week.
What kind of commodity is A?
+ 75 x 100
200
1 = + 37.5% = + 7.5 A normal good eg biscuits
+ 5%
+ 5%
What is the income elasticity of demand for commodity
B if demand increases from 5,000 to 5,500 units per
week when when real income falls by 2.5%.
+500 X 100
5,000
1 = + 10% = - 4
-2.5%
- 2.5%
What kind of commodity is B?
A giffen good eg bread
CHANGES IN DEMAND
When there is a change in a determinant of demand other
than price then the demand curve shifts .
Price
D1
If tastes change in favour
D
of a commodity then more
is demanded at all prices
and the demand curve shifts
D
D1
forward to the right.
Quantity Demanded
Price
D
D1
D1
D
Quantity Demanded
If the price of a substitute falls
then less of the commodity will
be demanded at all prices and the
demand curve shifts backward to
the left.
QUIZ
Say what happens to demand in each of the following cases:
The demand for a normal good A contraction in quantity
when its price rises.
demanded.
The demand for a luxury good
An extension in quantity
when its price falls.
demanded
The demand for a giffen good
A backward shift in demand
when income rises.
to the left.
A forward shift in demand
The demand for a good when
the price of its complement falls. to the right.
The demand for a good when the A forward shift in demand
price of a close substitute rises. to the right.
The demand for a good which has A backward shift in demand
recently been declared bad for to the left.
health.
SUPPLY
 the willingness to sell a commodity at a given price
THE LAW OF SUPPLY
More will be supplied at higher prices and less at lower prices.
Price
s
s
Quantity Supplied
A fall in price results in
a contraction of supply
There is a direct relationship between
price and quantity supplied resulting in
a supply curve sloping upwards from
left to right.
An increase in price results in
an extension of supply
Price
Price
Quantity
Supplied
Quantity
Supplied
ELASTICITY OF SUPPLY
 measures the responsiveness of supply to changes in price
E = % change in Quantity Supplied
% change in Price
Depends on the ability of suppliers to respond to price changes
therefore depends on:
 the time it takes to alter production levels
 availability of stocks
 availability of factors of production
 the ease of entry of new firms into the market
An increase in costs will
A decrease in costs will
shift supply to the left.
shift supply to the right.
Price
S1
Quantity
Supplied
P rice
S
S
Quantity
Supplied
S1
THE PRICE MECHANISM
Prices are determined by market forces ie the interaction
of supply and demand.
Price
D
S
Ep
D
Eq
QuantityDemanded & Supplied
The interaction of supply and demand determines the market clearing price
ie equilibrium price – the price at which all goods supplied are demanded.
Any price above this will mean excess supply which will force price down.
Any price below this will mean excess demand which will push up price.
Equilibrium price will change with changes in demand and/or supply in
Response to changes in the determinants of demand and supply.
INTERVENTION IN THE MARKET
This happens when there is market failure or the price system is not
working properly ie the price is too low or too high for those involved
The Government may set a maximum price to protect the purchasers.
Price
D
S
E
MaxP
S
If the maximum price set (Maxp) is below
equilibrium price, there will be excess
demand which could result in a “black market”
for the commodity.
D
Quantity
The Government may set a minimum price to protect the incomes of
the suppliers eg the minimum wage in the labour market.
Price
If the minimum price set (Minp) is
above equilibrium price, there will be
excess supply which, in the labour
market, too high a minimum wage would
cause unemployment.
D
S
MinP
E
S
D
Quantity
TAXES AND SUBSIDIES
Intervention in the market can also be by means of government taxes and
subsidies.
Indirect taxes eg excise duty are placed on products in order to
raise revenue for the government and/or to discourage consumption
of certain commodities such as cigarettes and alcohol.
P
Taxes have the effect of shifting the supply
curve to the left thereby increasing price.
D
S1
S
P1
P
S1
S
Q
Subsidies are given to producers to encourage the production of
certain products.
P
D
S
S1
P
P1
S
S1
Q
Subsidies have the effect of shifting the supply
curve to the right thereby lowering price.
CHANGES IN EQUILIBRIUM PRICE
Equilibrium price will change whenever there is a change in any of the
determinants of demand and/or supply.
Any of these changes in determinants (other than price) cause shifts in the
demand and/or supply curves, altering the market
clearing price.
P
FORWARD SHIFT IN DEMAND BACKWARD SHIFT IN DEMAND FORWARD SHIFT IN SUPPLY
INCREASES EQUIL PRICE
DECREASES EQUIL PRICE
DECREASES EQUIL PRICE
D
D1
P
D
S
P
S
P
S1
S
D1
D
D
D1
P
Q
D
Q
BACKWARD SHIFT IN SUPPLY COMBINATION OF SHIFTS
INCREASES EQUIL PRICE
INCREASING EQUIL PRICE
P
D
S1
S
P
D1
Q
COMBINATION OF SHIFTS
DECREASING EQUIL PRICE
D
P
S1
S
S
D
D1
D
Q
S1
D1
D
D
D1
Q
Q
AND FINALLY ……
Complements such as CDs and CD players are said to be
in joint demand since one is no use without the other.
Close substitutes such as butter and margerine are
said to be in competitive demand since they both
perform the same function and consumers will
choose between them.
Joint supply is where the production of one product
eg oil automatically leads to the production of another
eg petrol or paint or plastics
Where the total supply of one commodity is fixed
because of limited resources, a reduction in the supply
of one necessitates the reduction of another – these
are said to be in competitive supply eg milk and cheese.
QUIZ
What factors changes equilibrium Changes in any of the determinants
price?
of demand and/or supply.
Give 2 examples of market
intervention.
The minimum wage and price
capping.
Why might governments intervene
in markets?
To encourage the consumption of
some products and discourage
others.
Tennis racquets and tennis balls.
Name 2 products in joint demand.
Name 2 products in joint supply.
Give an example of products in
competitive demand.
Give an example of competitive
supply.
Beef and leather
Gas and electricity
Land for housing and land for
recreation